Evening Brief – 07.26.23

The Federal Open Market Committee announced a widely expected 0.25 percentage point interest rate increase in the Fed funds rate on Wednesday, bringing the benchmark overnight interest rate to between 5.25%-5.50%.

It’s the 11th hike since the Fed began to tighten monetary policy in March 2022, surpassing the highs of the 2006-2008 tightening cycle when the Fed funds rate peaked at 5.25%.

The FOMC kept the language that it would “continue to assess additional information and its implications for monetary policy,” and that in “determining the extent of additional policy firming that may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

The only changes compared with the June statement was revising the “continued to expand” language in the first sentence to “been expanding,” slightly upgrading the economic assessment from expanding at a “modest” pace to expanding at a “moderate” pace.

Perhaps the key sentence remains is one we’ve heard repeatedly: “The Committee remains highly attentive to inflation risks.”

With the market pricing in the lowest implied volatility ahead of today’s meeting since at least 2021, the market reaction was quite subdued with stocks, bonds and the dollar little changed.

Yet, the FOMC still finds itself in an undesirable situation. The unemployment rate is where it was when the central bank started its tightening campaign, while financial conditions are now much looser than they were last September.

Moreover, the S&P500, and many other equity indices, are trading back where they were just as the Fed started to hike interest rates. At the same time, commodity prices are starting to turn higher, possibly throwing a spanner in the Fed’s work.