What happened? 

As was widely expected, the Federal Open Market Committee (FOMC) left interest rates unchanged. Prior to the announcement, the market was already pricing in a <1% chance of a hike at the meeting. The Fed kept the door open for further rate hikes, though. The median forecast from the committee is for one more hike this year and then a modest set of cuts next year. That said, 12 officials see one more hike, while 7 see the Fed on hold from here. They maintained their language in the accompanying statement that they will assess “the extent of additional policy firming,” indicating they retain their tightening bias and that rate cuts are not currently at the top of their minds. All of that is roughly in line with the market’s expectations and we don’t believe today’s rate decision or statement has changed the picture around the Fed’s priorities or flexibility to adjust to further data.

Moving forward

While Chair Powell said in his press conference that he wouldn’t call a soft landing a baseline expectation, the Fed’s latest forecasts do clearly reflect that scenario. They expect inflation to return to target over the next three years without unemployment ever moving above 4.1% or GDP growth falling below 1.5% YoY. That would be an extraordinary outcome in any cycle and even more so in this one given how high inflation has been and remains.

Chair Powell reiterated that he believes a path to a soft landing exists and that it has widened lately. Recent economic data has shown inflation easing without meaningful softening in the labor market or weakening in the economy.

The question from here is whether the soft landing to date will hold going forward or if the data will weaken from here. Can the Fed get inflation to converge to its 2% target without causing economic pain? It isn’t impossible, but to many, the path seems narrower than it appears the Fed believes it to be.

While an economy doesn’t just slow its way into a recession, there’s something to be said for the idea of “stall speed,” with growth coming in so low that the economy isn’t as robust to random shocks. With household savings balances diminishing, credit conditions tightening, and progress on inflation slowing, it seems logical that the economy will be more vulnerable to shocks next year than it was this year. That doesn’t mean the apple cart will be turned over, but the risk is increasing. One such shock is the recent increase in energy prices, which could affect industrial production and consumer demand as well as driving inflation higher and requiring further rate hikes. The oil price move to date could be short-term, but if it persists, it will pose a risk.

All of that said, the Fed deserves an enormous amount of credit for how well it has managed the latter part of this cycle, especially after its late start to hikes last year in the face of a worsening inflation picture. Right now, the economy is on track for a soft landing. The question is just how long that will remain the case. The Fed is all-in on it being sustainable and many remain more skeptical. That suggests Treasuries could rally and rates could fall in the coming months as data turns weaker. But that is not a foregone conclusion either. For now, the Fed can hang its hat on having done a considerable job to date.