• Other policy rates such as the interest rate on excess reserves (IOER – rate paid to banks for reserves) and the overnight reverse repo rate (RRP – rate paid to funds for overnight deposits) were also raised to 3.90% and 3.80% respectively.
• The Federal Reserve’s “quantitative tightening” program is now moving forward in earnest, with the Fed capped at $95bn total per month of balance-sheet reduction. Since its peak this year on April 13th of $8.97 trillion, the balance sheet has been lowered by over $250bn to $8.7 trillion as of October 26th. As a reminder, the announced monthly “cap” for now is $60bn in Treasuries and $35bn in mortgage-backed securities.
• The FOMC statement noted several points: First, “ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive”. Second, “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags in which monetary policy affects economic activity and inflation, and economic and financial developments.”
• The market will likely interpret this as a key message change versus previous meetings. While the Fed is still focused on bringing inflation down to its target 2% rate, and to do so will continue increasing rates, going forward the Fed might “step down” its pace of rate hikes from 75bps per meeting to a slower pace of hikes.
• Fed Chairman Jerome Powell noted in his press conference after that: “at some point” it will become “appropriate to slow the paces of increases.” Powell also said that there is “significant uncertainty” in the policy rate, and that the ultimate terminal rate might be higher than previously expected (the Dot Plot shows a 4.625% median terminal rate). He also noted that the “time to slow rate hikes may start as soon as next month.”
• But he also noted that “it is very premature” to think about pausing rate hikes and indicated that the Fed would prefer to err on the side of over-tightening.

Our takeaways

• It is likely that the Fed will now indeed “step-down” the pace of its rate hikes, as its statement referenced both the “cumulative tightening of monetary policy” as well as “the lags affecting economic activity”. The Fed seems to be – finally – moving closer to a “balance of risks approach” but they are not thinking about pausing rate hikes. Given that the Fed would prefer to overtighten into restrictive territory, they will probably push rates towards and possibly above 5%.
• The only good news we see in today’s announcement is the possibility that the Fed takes a bit longer to tighten when it adopts a slower pace which we would expect soon. This may allow the lagged economic consequences of the Fed’s rapid tightening to be revealed. With that said, the focus on trailing inflation measures suggests the Fed will tighten into a recession in 1H 2023, which is our base case view.
• We continue to prefer fixed income allocations in short-to-intermediate durations and “up in quality”, so as to avoid potentially large mark-to-market drawdowns should the market for longer-dated debt experience heightened volatility. While we think that longer-dated debt at current yields will potentially result in gains for investors, the path to realizing returns may be chaotic.