What To Look For In The Fed’s February Interest Rate Announcement

At 2.30pm ET on Wednesday, February 1, the Fed will announce their first decision of 2023 for the Federal Funds rate. An increase of 0.25 percentage points, taking rates to 4.50-4.75% is firmly expected. Yet, the market will want clues for future decisions and will likely get some at the press conference, if not in the written statement.

A 0.25 percentage point hike would represent continued tapering from larger increases in 2023 as the Fed gets close to maximum rates for this cycle and inflation fears begin to ease. There will be a press conference, but no Summary of Economic Projections (SEP) at this meeting.

Looking Toward The Spring

The key questions center on how rate decisions in the spring will play out. The markets expect small hikes in February and March, but that’s it. In contrast, the Fed has signaled that at least a third hike may be needed, taking rate increases to the May meeting and perhaps beyond. It will be interesting to observe if the Fed holds the line on signaling raise rates into the spring. It is possible that the recent run of favorable inflation data has given the Fed greater confidence that prices are under control.

Recent Inflation Data

The markets optimistically see inflation on a declining trajectory, but Fed officials have recently worried that core inflation is stubbornly high, and that upside risks to inflation remain.

The Fed’s Concerns

The Fed’s concerns are founded on wage inflation running hot, but there are also concerns about services inflation persisting and mark-ups by companies continuing to keep prices high. The Fed also expects to see house prices come down in the inflation figures over the coming months, bringing inflation lower.

PCE Data

The Fed’s preferred inflation measure, core PCE inflation was reported at a 4.4% annual rate for December 2022. Although it has trended down in recent months, the Fed may argue it hasn’t fundamentally changed from the 4.9% annual rate we saw in August 2022, and the 0.3% change in core prices month-on-month that we saw in December still implies annual inflation of over 4%, above the Fed’s target.

As such, markets will be watching for clues that the Fed is getting comfortable that inflation will return to their target 2% level in short order, or if they want to wait for further evidence. The strong job market has given the Fed a little breathing room here as fears of near-term recession have receded. Of course, the Fed will remain data dependent, and if inflation readings for January and February aren’t encouraging, then rates may move higher than the market currently anticipates.

The second piece is assessing the Fed’s resolve to hold rates at a high level throughout 2023. The Fed has been clear that in intends to do so, but the market suspects that a weaker economy, or perhaps subdued inflation, could prompt the Fed to cut rates later in the year.

New Faces

Though this is unlikely to impact policy, the make up of the committee will also change in 2023 and this will be the first rate decision for this new group. The majority of members remain the same, and of course Jerome Powell remains chair, but the regional banks represented on the committee will change for 2023 as is the case each year. For 2023, Presidents of the Federal Reserve Banks of Chicago, Philadelphia, Dallas and Minneapolis become members of the committee as other Presidents roll off. Overall, this doesn’t appear to tilt the Fed in either a more hawkish or dovish direction when setting rates.

What To Look For

Expect a 0.25 percentage point hike on Wednesday, February 1, but the market will be watching for the Fed’s resolve in hiking rates into the spring. In part, Jerome Powell’s discussion of inflationary trends will provide some clues here. If he’s more cautious, then hikes may exceed the market’s expectation, but if he is more encouraged by recent data, then maybe the Fed will end hikes sooner than expected.

Either way, current expectations are for the Fed Funds rate to remain broadly around the 5% level for 2023. The finer detail is whether rates exceed 5% for 2023 as the Fed has forecast, or remain just under that level, as the market currently believes.