Beyond the headlines of the 25 bps fed funds hike, here’s what else has changed:

- Terminal rate forecast up i.e the rates are expected to end up even higher
- GDP estimates cut significantly for the current year
- Stagflation risks are on the Fed's radar with upside risk on inflation and downside risk on growth
- Our read was that price stability will retain primary importance for the Fed, and maintaining employment/growth is lower down the list of priorities

The US Federal Reserve hiked rates by 25 basis points, moving the target fed funds target range to 0.25%-0.50%. The Federal Open Market Committee (FOMC)’s projections (dot plots) show a median of 7 rate hikes this year as the market (implied by interest rate futures) had already priced in. 

BUT, the change was that the terminal rate (i.e. the interest rate peak for the current hiking cycle) projection was increased by +70bps to 2.8%. Meanwhile, the neutral rate projection (i.e. interest rate that supports the economy at full employment/maximum output while keeping inflation constant) was lowered by 10bps to 2.4% from 2.5%.

This implies that the Fed intends to hike rates to a level that is 40bps above neutral to tackle high inflation.  

The FOMC’s GDP forecast remains constant in 2023 and 2024 at 2.2% and 2.0% respectively while the current year (2022) number has been slashed substantially from 4% to 2.8%.  

On the other hand, both headline and core inflation forecasts were bumped higher with Core CPI projected at 2.6% in 2023 vs 2.3% previously, despite a decent number (7) of rate hikes being penciled in for the year.  

It is noteworthy that stagflation risks are on the Fed's radar, as implied by the materially upgraded inflation profile vs the balance of risks to growth.

During the Q&A, Chair Powell suggested that every meeting is a live meeting (i.e. open for a rate hike) and that if it's appropriate they may hike by more than 25bps in any given meeting.

On the balance sheet run-off or quantitative tightening, Powell exclaimed that the committee has made “excellent progress” on the balance sheet plan and that they could finalize a balance sheet plan at the next meeting in May. 

Based on the Chair’s long-winded response to a question about the trade-off between higher unemployment and accelerating inflation, our read was that price stability will retain primary importance for the Fed. 

Finally, looking at the market reaction, the curve flattened significantly as 2Y yields touched ~2% before settling closer to 1.91% while 30Y yields declined 2-3bps to 2.45%. The spread between 5Y and 10Y treasury yields briefly turned negative. 10Y real yields (inflation-adjusted yields) jumped ~9bps to -0.63%

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