The U.S. Federal Reserve (Fed) delivered a smaller rate hike on December 14 but remained resolute in its efforts to tamp down inflation through tighter monetary policy. At the conclusion of its two-day meeting, the Federal Open Market Committee (FOMC), the Fed’s policy-setting arm, raised the target interest rate by 50 basis points (bps) following four consecutive 75-bp moves, representing the seventh increase of the current tightening cycle.

As expected, the FOMC increased the mid-point of its policy rate range from 3.875% to 4.375%. It also indicated that rates needed to rise further to be sufficiently restrictive. The statement following the meeting was unchanged from the previous one despite two consecutive months of lower inflation data.

The updated quarterly Summary Economic Projections (SEP) and the press conference after the December FOMC meeting were, on balance, bearish.

  • The updated SEP showed median fed funds rate projections at 5.1% (+0.5% above the September SEP forecast) at the end of 2023, 4.1% (+0.2%) at the end of 2024, and +3.1% (+0.2%) at the end of 2025. The increases were due to a more persistent inflation problem than was apparent at the September FOMC meeting, and the consequent need to raise rates to a higher level and keep them there for longer.
  • Seventeen out of 19 forecasters pegged rates at 5.1% or higher at the end of 2023 and only two expected rates to be below 5.1%. The skew in 2024 and 2025 was also to the upside.
  • The unemployment rate was expected to increase to 4.6% (+0.2%) by the end of 2023, remain at that level at end of 2024 (+0.2%), and decline to 4.5% (+0.2%) by the end of 2025. That is consistent with around 0% GDP growth in 2023 and on-trend economic growth thereafter. The SEP forecast for GDP is for 0.5% in 2023, 1.6% in 2024, and 1.8% in 2025.
  •  At his post-meeting press conference, Fed Chair Jerome Powell reiterated that the labor market remained “substantially out of balance,” with labor demand exceeding labor supply and a “structural’ deficit of about 3.5-4 million workers due to retirements, deaths from COVID, and low migration.
  • Powell said the reduction in the pace of price increases evident in the November CPI report is “welcome” but it is merely in line with the Fed’s prior forecasts, and it will take “substantially more evidence” before concluding that inflation is on a sustainable downward path.
  • The Fed chair also stated that stable inflation expectations were “no ground for complacency” as actual inflation remained above target.
  • He pointed out that 50 bps is still a “historically large rate increase” and that the FOMC still has a way to go before pausing, running directly counter to the market optimism engendered by the November CPI release. Powell reiterated that the historical record clearly shows the danger of pausing too soon.

One potential positive development: Powell concurred that the pace of rate increases should now be more gradual in response to a question probing whether the Fed wanted to guide towards 25-bp increases at future meetings. Of course, he made no such commitment and simply agreed in general that with rates now in restrictive territory it would be appropriate to move in smaller increments.

The key takeaway from the December FOMC meeting: Anyone looking for a dovish policy signal based on recent data showing the pace of inflation has slowed will have been disappointed. As such, we would reiterate our view from previous commentaries that investors may wish to focus on those asset classes that have historically weathered periods of inflation and higher interest rates.