The Federal Reserve’s pause may be temporary even as inflation cools
The Federal Reserve forecasts further interest rate increases this year even after it paused its hiking campaign spanning 15 months.
Commentary
The Fed hits pause after a 15-month tightening cycle to evaluate state
of the economy
The Fed agreed to hold interest rates steady in June after 10 consecutive increases
but signaled it would likely resume tightening to cool inflation and the economy. A
series of rate hikes by the central bank since March 2022 has taken the benchmark
federal funds rate to a target range of 5.00%–5.25%, the highest level since 2007.
1
At that policy meeting in June, the Federal Open Market Committee (FOMC) stated
that to determine “the extent of additional policy firming that may be appropriate”
to bring inflation to the 2% target, policymakers will consider the “cumulative
tightening of monetary policy, the lags with which monetary policy affects
economic activity and inflation, and economic and financial developments.”
2
New economic projections released in June showed the Fed expects to raise
rates—albeit at a slower pace—to 5.6% by year-end 2023, which was an increase
from the previous projection for their end-of-year policy rate of 5.1% made at their
March meeting (Exhibit 1, page 2).
3
The current forecast implies officials expect
two additional quarter-point rate hikes before the end of the year. Furthermore, the
FOMC projects to lower rates to a median 4.6% by the end of 2024 compared to
their previous projection of 4.3% from March.
Money markets
The Federal Reserve’s pause may be temporary even as
inflation cools
KEY TAKEAWAYS
•
The Federal Reserve forecasts further interest rate increases this year even after it
paused its hiking campaign spanning 15 months.
•
U.S. jobs growth remained strong and consumer confidence jumped to the
highest level since early 2022, indicating a resilient economy.
•
The rising supply of U.S. Treasury bills was well absorbed by investors as more
issuance looms on the horizon.
•
We anticipate that assets at money market funds will continue to grow during the
second half of 2023, albeit at a slower pace, amid increased competition.
Kerry Pope, CFA
Institutional Portfolio Manager
Money markets
|
2
Source Bloomberg Finance L.P., as of June 30, 2023.
EXHIBIT 1: The Fed’s projections for its policy rate in 2023 and 2024 are higher than the market expected
federal funds rate.
Fed Funds Futures vs. FOMC’s Forecasted Rates
During a panel discussion at a European Central Bank (ECB) forum in June, Fed Chair Jerome
Powell said interest rate policy has not been restrictive long enough.
4
He signaled policymakers
could potentially raise rates further to curb persistent price pressures and cool a surprisingly
resilient U.S. labor market. The Fed is not the only central bank seeking to raise rates further
to thwart inflation. ECB President Christine Lagarde said the European policymakers still have
ground to cover on borrowing costs and is “very likely” to raise again in July. Australia’s central
bank and the Bank of England have recently raised interest rates as well with the threat of further
interest rate hikes in the future.
Although inflation readings have slightly cooled in May, they remain well above the Fed’s target. The
FOMC’s Summary of Economic Projections in June show officials expect the personal consumption
expenditures (PCE) price index ending the year at 3.2% compared with 3.3% forecast in March. The
core PCE inflation, which excludes the more volatile food and energy categories, is projected at
3.9% in 2023 compared with March’s estimate of 3.6%. In May, however, core PCE was at 4.6% year-
on-year, down from 4.7% the prior month, according to the U.S. Department of Commerce.
5
The
PCE price index rose 3.8% in May from a year earlier, its lowest reading in two years.
The consumer price index (CPI) rose 4% in May from a year earlier, well below the peak of 9.1% in
June 2022 and down from April’s 4.9% increase, according to the Labor Department.
6
Core CPI,
which excludes volatile food and energy components, increased 5.3% in May from a year earlier,
down from 5.5% in April.
Strong employment and consumer confidence extends the economic growth cycle
The U.S. economy grew faster than previously forecast in the first quarter of this year. Gross
domestic product (GDP), adjusted for inflation, expanded at an annual rate of 2%, the Commerce
0%
1%
2%
3%
4%
5%
6%
Mar-23
Jun-23
Sep-23
Dec-23
Mar-24
Jun-24
Sep-24
Dec-24
Mar-25
Jun-25
Sep-25
Dec-25
Mar-26
Jun-26
Sep-26
Dec-26
Mar-27
Jun-27
Sep-27
Dec-27
Fed Funds Futures (5/31/23)
FOMC Dots (6/14/23)
Fed Funds Futures (6/30/23)
Money markets
|
3
Department said. That was an upward revision from
a prior estimate of 1.3%. Consumers are powering
the recovery through their spending, which increased
4.2% in the first quarter, up from 3.7% in April. In their
own projections released at their June policy meeting,
the Fed increased its expected GDP growth for the
year to 1%, up from a projected 0.4% in March.
Even with the tightening of monetary policy, the labor
market has remained resilient. The unemployment
rate ticked lower to 3.6% in June.
7
According to
the FOMC’s projection, the unemployment rate
is forecast at 4.1% this year and 4.5% in 2024.
Meanwhile, U.S. consumer confidence jumped in
June to its highest level in 18 months as a strong labor
market continued to buoy the economy.
8
The flurry of recent economic data pointed to a U.S.
economy that is exceeding expectations and proving
resilient to the Fed’s tightening campaign. While the
current data does not rule out the possibility of a
recession in the coming year, the data also does not
give us reason to believe a downturn is imminent. As
a result of the recent stronger economic data, many
economists have been forced to delay their forecast for
a recession until 2024. Powell said in June he does not
view a recession as the most likely outcome although
there is the potential for an economic downturn. Low
employment levels boosted by government spending,
tax credits, labor hording, investments in artificial
intelligence (AI) and consumer spending have created
an extended late-cycle environment.
Still, we cannot rule out growing risks. Student loan
repayments will re-start later this year and it remains to
be seen what impact the regional banking crisis has on
overall lending and capital spending. In addition, the
draining of liquidity via the U.S. Treasury Department’s
debt auctions and the Fed’s further shrinking of its
asset portfolio (quantitative tightening) give concern
that a slowdown may still be ahead.
Robust demand for U.S. Treasury bill auctions
as more issuance looms on the horizon
The large increase of Treasury Bill supply began after
President Joe Biden signed into law a bill to lift the
nation’s debt ceiling in early June. As a result, the
Treasury Department issued nearly $500 billion of bills
in June. The Treasury had used its general account
balances (TGA) at the Fed and adjusted its stock of
bills to remain under the ceiling before the June debt
agreement. The net increase of supply will result in
a rebuild of the Treasury’s cash balance to meets its
target of $425 billion at the end of June (Exhibit 2).
Source Bloomberg Finance L.P., as of June 30, 2023.
EXHIBIT 2: Changes in the Treasury General Account (TGA), the reverse repo facility (RRP), and Treasury bills.
–0.6
–0.4
–0.2
0
0.2
0.4
0.6
Jan-23
Feb-23
Mar-23
Apr-23
May-23
Jun-23
Changes in $ Trillions
RRP
TGA
Bills
Money markets
|
4
The Treasury is expected to further rebuild its TGA balance to $600 billion by the end of
September, which will require an estimated $700 billion to $750 billion in additional bill sales
in the second half of the year.
To date, market participants have well absorbed the increase of Treasury bill issuance
(Exhibit 3). Evidence thus far suggests that money market funds, with access to the Fed’s
reverse repurchase agreement (RRP) facility, have been willing buyers of the initial increase of
bills supply as the overall market’s participation in that facility declined by $200 billion in June.
We think demand for the increased supply has also come from investors who do not have
access to the Fed’s RRP facility, including U.S. companies, retail investors, municipalities, and
separately managed accounts (SMAs). Demand from these investors may have implications for
bank reserves. Should a significant outflow in bank reserves occur, that may cause the Fed to
eventually adjust its quantitative tightening (QT) program—where the central bank is steadily
reducing its Treasury and mortgage-backed security holdings—earlier than anticipated.
Source: Bloomberg Finance L.P., as of June 30, 2023.
EXHIBIT 3: The yields on U.S. Treasury bills have trended higher in the second quarter of 2023 from
the end of Q1.
Treasury Bills
Debt outstanding at the Federal Home Loan Bank (FHLB), a government sponsored
entity (GSE) representing 11 regional banks, was approximately $1.36 trillion as of quarter
end, which represented a decline of $172 billion from the $1.53 trillion it reported at the
end of May. After having provided funding to the banking system that bolstered banks
liquidity during the regional banking crisis in mid-March, the recent decline of FHLB’s debt
outstanding is a welcome sign of bank stress levels subsiding. However, the recent decline
of FHLB issuance has limited the amount of money market eligible supply, which has also
contributed to the industry’s willingness to participate in the Treasury bill market.
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
3/31/23
4 / 7/ 23
4/14/23
4/21/23
4/28/23
5/5/23
5/12/23
5/19/23
5/26/23
6/2/23
6/9/23
6/16/23
6/23/23
6/30/23
1 Month
3 Month
6 Month
12 Month
Money markets
|
5
Money market funds will grow at a slower pace in the second half amid
rising competition
Assets under management at money market funds have climbed this year as
investors were attracted by the increased yields that are available in a highly liquid
product (Exhibit 4). Government money market funds have attracted more than
$500 billion so far this year. Prime money market funds’ assets have also increased
$153 billion year-to-date to $820 billion as of the end of June. The Fed’s policy
increases, the debt ceiling debate and bank failures were drivers of flows in the first
half of the year.
We anticipate that money market funds will continue to grow during the second
half of 2023. We, however, expect this growth to occur at a slower pace than
experienced in the first half of this year. Our expectation for the slower asset
growth is based on the direct competition that is expected from the increase of
Treasury supply, as well as from the banking industry which may feel inclined to
defend or grow their deposit base with higher offering rates for traditional banking
products. Ultimately, the pace and direction of the asset change will be dictated by
the Fed’s reaction function to how the economy evolves as we soon approach what
is believed to be the end of this tightening cycle.
Source iMoneyNet, as of June 30, 2023.
EXHIBIT 4: Government and prime money market funds have attracted inflows from investors.
Government and Prime Money Market Fund Year-to-Date Growth ($ Billions)
$523B
$153B
–$100
$0
$100
$200
$300
$400
$500
$600
Dec-22
Jan-23
Feb-23
Mar-23
Apr-23
May-23
Jun-23
Gov't MMF
Prime MMF
Money markets
|
6
As of this publication, the Securities and Exchange Commission (SEC)
changed rules governing money market funds. Please see highlights below.
SEC adopts money market fund reforms and amendments
On July 12, the Securities and Exchange Commission (SEC) adopted amendments to certain rules
that govern money market funds under the Investment Company Act of 1940. Below are some key
excerpts from the SEC’s Fact Sheet.
9
•
Increasing minimum liquidity requirements to provide a more substantial buffer in the event
of rapid redemptions. The amendments will increase the minimum liquidity requirements for
money market funds to at least 25% of a fund’s total assets in daily liquid assets and at least
50% of a fund’s total assets in weekly liquid assets. These amendments will provide a more
substantial buffer that will better equip money market funds to manage significant and rapid
investor redemptions in stressed market conditions while maintaining funds’ flexibility to invest
in diverse assets during normal market conditions.
•
Removing provisions from the current rule that permit a money market fund to temporarily
suspend redemptions and removing the regulatory tie between the imposition of liquidity fees
and a fund’s liquidity level. The amendments will remove money market funds’ ability to impose
temporary gates to suspend redemptions. They will also remove the regulatory tie that permits
money market funds to impose liquidity fees if their weekly liquid assets fall below a certain
threshold. These changes will reduce the risk of investor runs on money market funds during
periods of market stress.
•
Requiring certain money market funds to implement a liquidity fee framework that will better
allocate the costs of providing liquidity to redeeming investors. The amendments will require
institutional prime and institutional tax-exempt money market funds to impose mandatory
liquidity fees when a fund experiences daily net redemptions that exceed 5% of net assets,
unless the fund’s liquidity costs are de minimis. In addition, non-government money market
funds must impose a discretionary liquidity fee if the fund’s board (or its delegate) determines
that a fee is in the best interest of the fund.
•
Enhancing certain reporting requirements to improve the Commission’s ability to monitor and
assess money market fund data.
The rule update is outlined below:
https://www.sec.gov/news/press-release/2023-129
https://www.sec.gov/rules/final/2023/33-11211.pdf
Read Fidelity’s Q&A on the SEC’s money market regulatory reform here
.
Learn more about Fidelity’s Money Market Funds here
.
1
Federal Reserve, June 2023. https://www.federalreserve.gov/monetarypolicy/openmarket.htm.
2
Federal Reserve Board, June 14, 2023. https://www.federalreserve.gov/newsevents/pressreleases/monetary20230614a.htm
3
Federal Reserve, June 2023. https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20230614.pdf
4
The
Wall Street Journal
, June 28, 2023. https://www.wsj.com/video/powell-interest-rate-policy-hasnt-been-restrictive-long-enough/34688C17-1107-4F8F-
A4CD-D3AFC1E3A10C.html
5
U.S. Department of Commerce, June 30, 2023. https://www.bea.gov/sites/default/files/2023-06/pi0523.pdf
6
U.S. Bureau of Labor Statistics, June 13, 2023. https://www.bls.gov/news.release/pdf/cpi.pdf
7
U.S. Bureau of Labor Statistics, July 2023. https://www.bls.gov/news.release/empsit.nr0.htm
8
The Conference Board, June 2023. https://www.conference-board.org/topics/consumer-confidence/press/CCI-June-2023.
9
https://www.sec.gov/files/33-11211-fact-sheet.pdf
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Author
Kerry Pope, CFA
Institutional Portfolio Manager
Kerry Pope is an institutional portfolio manager in the Fixed Income division at Fidelity Investments. In this role, he is responsible for
communicating portfolio strategy and positioning, designing customized liquidity management solutions for institutional clients, and providing
portfolio reviews.
Fidelity Thought Leadership Vice President Shanthy Nambiar provided editorial direction for this article.
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