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Friday, January 20, 2023

Monetary Policy: The Pause that Refreshes?

by Calculated Risk on 1/20/2023 09:14:00 AM

This morning BofA economists noted a possible shift in FOMC policy:

[O]ur baseline outlook for monetary policy includes 25bp rate hikes in February, March, and May of this year.

That said, if the Fed is comfortable downshifting to 25bp in February, it may be a signal that the committee is closer to terminal than it (and we) thought as recently as December. Recent trends in inflation look more favorable – and trends in economic activity look less favorable – than the median FOMC member projected in December. Should these trends continue, it could open the door for a pause in rate hikes as early as the March FOMC meeting (at a terminal of 4.75-5.0%). FOMC participants could justify this on account of risk management – pausing to assess the lagged effects of prior tightening – or from a real policy rate perspective. The December projections suggest the median member desires a real policy rate of around 150bp; an earlier pause to hikes would prevent monetary policy from becoming “too tight” as inflation falls. Again, this is not our baseline outlook, but, if history is any guide, turning points in the economy can be abrupt, and we cannot rule out an earlier end to policy rate tightening based on the November-December data flow.
This is close to my current view: Question #6 for 2023: What will the Fed Funds rate be in December 2023?