• The FOMC raised the federal funds rate by 25 basis points at its policy meeting and continued to reduce the size of the central bank’s balance sheet.
• The statement, and Powell’s press conference, both point to multiple rate increases in the fed funds rate in the near term.
• PNC expects the FOMC to raise the fed funds rate only one more time this year, at the FOMC’s next meeting in mid-March. This would take the fed funds rate to a range between 4.75 and 5.00%.
• PNC expects a mild recession in 2023, with a deterioration in the labor market and a slowing in inflation toward the FOMC’s 2% objective.

The Federal Open Market Committee raised the federal funds rate, its key short-term policy rate, by 25 basis points this afternoon as expected. The funds rate is now in a range between 4.50% and 4.75%.

The FOMC had raised the fed funds rate by 50 basis points at each of the two previous meetings, and by 75 basis points at each of the four meetings before that. The fed funds rate started 2022 between 0% and 0.25% and has increased dramatically since then as the FOMC has raised interest rates to combat elevated inflation.

In its press release, the FOMC said that “ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.” The use of increases (plural) suggests that the FOMC will raise the fed funds rate at least two more times in the near term.

The FOMC continued to reduce the size of the Fed’s balance sheet by up to $95 billion per month, allowing maturing long-term Treasurys and mortgage-backed securities to roll off the balance sheet without replacing them. The shrinking balance sheet has been putting upward pressure on longer-term interest rates.

The statement noted that  “inflation has eased somewhat but remains elevated,” above the FOMC’s 2% objective. In his press conference, Fed Chair Powell said that the “disinflationary process has started” in goods, but that it would be “premature to declare victory” against inflation. In particular, Powell noted that services inflation, excluding housing, has yet to slow from its current elevated rate. He also notes that although wage growth has slowed by various measures, it remains “fairly elevated.”

The statement said that job growth has “been robust in recent months,” and that there has been “modest growth in spending and production.”

The statement was approved unanimously.

The FOMC is continuing to tighten monetary policy in early 2023. Right now the fed funds rate is above the neutral rate; that is, monetary policy is weighing on economic growth. But in his press conference, Powell said that there is “not yet a sufficiently restrictive policy stance.” That is, FOMC policymakers think that further rate increases are needed to bring inflation down to 2%. The statement said that further rate increases are likely. Although Powell noted slower inflation in recent months, especially for goods, and an expected slowing in housing inflation, he also said “inflation is still running very hot.” He also that is important that the FOMC doesn’t stop raising the fed funds rate before “getting the job done,” and that stopping rate hikes prematurely could allow inflation to remain above 2% over the medium term.

Powell noted that even if the economy doesn’t enter recession in 2023 growth is likely “fairly subdued.” But he also said that there was little likelihood of a “fairly significant downturn,” suggesting that there is a more substantial probability of a mild downturn.

The FOMC isn’t done yet. The statement and the Powell press conference point to at least two more 25 basis point increases in the fed funds rate, at the FOMC’s mid-March and early May meetings. However, PNC expects just one more 25 basis point increase in 2023, in mid-March. The difference comes from the outlook for the economy. PNC expects the U.S. economy to enter into recession over the next few months, which would deter the FOMC from raising the fed funds rate beyond the committee’s next meeting. The FOMC, however, is projecting weak economic growth in 2023, but no near-term recession, which would indicate at least two more rate increases this year.

With the rapid increase in both short-term and long-term rates over the past year or so, the most likely outcome is a mild recession in 2023. PNC expects a peak-to-trough decline in real GDP of around 1% through the end of this year, with the unemployment rate up above 5% by the end of 2023, from 3.5% in December 2022.