The Fed remains hawkish, but easing could occur in 2023

The U.S. Federal Reserve’s decision on Wednesday to raise U.S. interest rates by 75 basis points to 3.25% was well priced into the markets and, therefore, should come as little surprise to investors. The accompanying statement also contained little new information. Why did the markets react so strongly?

The devil, as the saying goes, is very much in the details. In this instance, we’re referring to the underlying message from the U.S. Federal Reserve (Fed). Wednesday’s announcement was accompanied by the FOMC’s latest economic projections, which is part of its closely watched federal funds rate projections (the dot plot). It’s fair to say that the latest projections and Fed Chair Jerome Powell’s post-meeting comments cemented an increasingly negative outlook. 

What did we learn from the Fed’s latest projections? 

  • The forecasts painted a gloomier picture—GDP growth forecasts for 2022 and 2023 were ratcheted down materially to 0.2% and 1.2%, respectively, on a year-over-year basis, down from 1.7% (for both years). Meanwhile, projections for unemployment and inflation were revised modestly higher. While the Fed’s updated outlook might not seem all that controversial relative to market consensus, recall that until recently, the central bank had painted a reasonably benign picture of the U.S. economy.
  • The federal funds rate is expected to stay higher for longer—The Fed’s median estimate of where the federal funds rate will be by the end of 2022 has been pushed up by a full percentage point to 4.4%. Crucially, Fed officials now expect the benchmark policy rate to hit 4.6% in 2023 before easing.
  • Hawkish comments from Chair Powell—The hawkish message that was implicit in the projected estimates was made explicit by Chair Powell during Wednesday’s press conference, during which he confirmed that the Fed’s first priority was to get inflation back to its target rate of 2%, and reiterated the central bank’s commitment to achieving that goal even if it meant compromising economic growth to get there.

Fed officials have turned more hawkish

FOMC projections Projected interest rate—median (%)
2022 2023 2024
June 3.4 3.8 3.4
September 4.4 4.6 3.9
Source: U.S. Federal Reserve, September 21, 2022. FOMC refers to the Federal Open Market Committee.

What’s changed?

We think two factors contributed to the Fed’s increasingly hawkish tone: First, although the employment picture had shown signs of softening earlier in the summer, recent data suggested that the labor market has strengthened since then. Second—and more important, in our view—was August’s outsized 0.6% (on a month-over-month basis) increase in core CPI.  

Prior to the release of August’s CPI data, we had envisioned a more modest path that would have seen policy rates peak at 3.5%, with the final hike for this cycle arriving just before year end. Now, we expect the federal funds rate to hit 4.25% in early 2023; with the possibility of an additional 25 basis points (bps) added to the peak rate should forthcoming inflation data remain stubbornly strong. Should that happen, our forecast will mirror the Fed’s own projections. In other words, we’re now in data-dependent territory.

The way we see it, inflationary pressure will have to come back down to a more manageable pace (e.g., staying in the 0.2% to 0.3% range for several months) before the Fed begins to consider pausing rate hikes.

Put differently, there probably isn’t enough time between now and the next Fed meeting for inflation data to weaken sufficiently to reasonably justify a modest 25bps rate hike in November—meaning that once again, the next hike is highly likely to be material. That said, the Fed could potentially provide the markets with a festive surprise in December and signal a willingness to slow the pace of hikes should upcoming economic data unfold in the right way (i.e., weaken significantly). That’s about as optimistic as we’d get.

We expect the Fed to start easing in 2023

We do, however, have higher conviction that the Fed will begin easing before the end of 2023 for two reasons:

  1. We expect inflation to moderate to a point where it’s not as acutely troubling as it is now by Q2 2023. There’s currently evidence that supply chain constraints are beginning to unwind. Further, the expected disinflationary pressure that’s typically associated with an inventory correction has yet to materialize—that should also contribute to putting a lid on inflation. Finally, key commodity prices have also started to ease. As these factors kick in, the Fed should have the breathing room that it needs to stop hiking and assess the impact that tighter monetary policy has had on the economy.
  2. In our view, monetary easing will only occur when growth concerns supersede anxiety about inflation. While Chair Powell has been clear about the risks of easing prematurely, the reality is that most forecasters—ourselves included—expect the U.S. economy to slip into recession during the first half of 2023. As such, the temptation to ease as soon as is plausible will likely increase over the coming months. 

A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments.  These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.

The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.

This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice.  This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.

Manulife Investment Management

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.

This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional

Australia: Manulife Investment Management Timberland and Agriculture (Australasia) Pty Ltd, Manulife Investment Management (Hong Kong) Limited. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad  200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltdwhich is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Manulife Investment Management Timberland and Agriculture Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.

Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

2437948

Alex Grassino

Alex Grassino, 

Head of Global Macro Strategy, Multi-Asset Solutions

Manulife Investment Management

Read bio