- Fixed Income Analyst
Iceland, Institutional
ChangeThe views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The Federal Open Market Committee (FOMC) raised the target federal funds rate by 75 basis points (bps), to a range of 2.25% to 2.50%, at its July 2022 meeting. The FOMC made no change to its plans regarding the ongoing reduction of its balance sheet, which began in June.
The rate increase, which was largely priced into markets, occurred as US inflation rose and the labor market remained strong. In recent weeks, however, manufacturing data has signaled slowing US economic growth. In addition, the US Treasury (UST) yield curve has inverted, meaning that the yield on shorter-dated UST debt now exceeds the yield on longer-dated UST debt — which, historically, has often portended recession.
Recession risks and inflation pressures have increased
The US Federal Reserve’s (Fed’s) own models of economic growth and inflation suggest that the risk of stagflation — rising inflation paired with falling growth — has increased. Going into the July meeting, the Atlanta Fed’s GDP measure indicated that the rate of change for second-quarter GDP was negative, while the New York Fed’s GDP measure showed slowing growth since the June FOMC meeting. At the same time, the most recent print of the Dallas Fed’s Trimmed Mean Personal Consumption Expenditures (PCE), an important gauge of core inflation pressures, came in at 4.0%. Most concerningly, it indicated that over half of the component prices of PCE had increased at an annual rate of more than 5%.
Taken together, these datapoints present a dilemma for the Fed. On one hand, signs of moderating economic growth suggest that removal of monetary policy accommodation could increase the risk of a US recession. On the other hand, the momentum in inflationary pressures implies that failure to remove policy accommodation could cause inflation expectations to increase.
Labor market strength persists, dampening near-term recession fears
While slowing manufacturing data and an inverted UST yield curve can be leading indicators of a recession, not all of the available data suggests that a recession is imminent or inevitable. In particular, the Fed is attentive to the continued resilience of the US labor market: The unemployment rate has remained near historic lows at 3.6%, while workers’ wages have continued to increase (although wage growth is negative in real terms). Initial jobless claims have ticked up slightly of late, but remain well below the elevated levels that prevailed for most of 2020 and 2021. Until the labor market deteriorates meaningfully, the Fed will likely continue to prioritize the removal of monetary policy accommodation in an effort to combat inflationary pressures.
Inflation expectations remain the key Fed policy determinant
When the Fed pivoted from enacting a 50-bps rate hike to a 75-bps hike at its June FOMC meeting, Chair Jerome Powell cited upward moves in survey-based measures of inflation expectations as a key driver of its policy shift. Since that time, survey-based measures of inflation expectations have come off their highs but remain elevated. Likewise, Treasury Inflation-Protected Securities (TIPS)-implied “breakeven” rates have dipped as energy prices have stabilized, but both the 5-year and the 10-year breakeven rates remain solidly above 2% as of this writing.
Indicators of inflation expectations will continue to be important inputs to Fed monetary policy going forward. Given the uncertainty about the economic outlook, the Fed would prefer to hike rates as little as possible, provided inflation expectations remain consistent with its mandate to keep average inflation at around 2%. Any material increases in inflation expectations would likely necessitate more aggressive removal of policy accommodation, whereas material decreases could bring the Fed’s current rate-hiking cycle to an earlier end than what’s now priced into markets.
Final thoughts for investors
In addition to its “price stability” and “maximum employment” goals, the Fed also takes its “financial stability” mandate seriously. With market volatility elevated and apt to remain so, the Fed will try to avoid contributing to that volatility with its words and actions, if it can. Absent an exogenous macro shock, I expect the Fed’s balance-sheet normalization to proceed as planned for the next few months. Its monetary policy will be informed by both incoming inflation data and labor market data. Given that recent data indicates more change in the former than the latter, the risk to interest rates for the foreseeable future appears to be to the upside.
Expert
Related insights
Showing
of
Insights Posts
Fed stays its course while acknowledging brewing winds of change
Continue reading
4
min
Article
2025-11-30
Rate relief: Fed cuts half point, but says “economy is strong”
Continue reading
3
min
Article
2025-09-30
URL References
Related Insights
Stay up to date with the latest market insights and our point of view.
Read next
Showing
of
Insights Posts
Fed stays its course while acknowledging brewing winds of change
Our expert examines the underlying data which drove the Fed to stay its rate-cutting course.
4
min
Article
2025-11-30
What do declining European earnings mean for ECB policy?
European companies have been unexpectedly resilient over the last couple of years. However, the outlook for European earnings could be more challenging than headline numbers suggest. What could this mean for investors?
6
min
Article
2025-11-30
What is “the economic cycle,” anyway?
See why the relationship between asset prices and the economic cycle is more complex than you might think, why a US recession is unlikely, and what a more dovish Fed could mean for the US and global markets.
5
min
Article
2025-10-31
Take it “ease”-y
Tim Antonelli, Head of Multi-Asset Strategy – Insurance and Portfolio Manager, explains why he thinks insurers should consider locking in current yields and sticking with global equity exposure.
18
min
Article
2025-10-31
Can central bank independence survive?
Can central bank independence survive? Macro Strategist John Butler discusses the challenges faced by central banks in an increasingly fraught political environment and how investors should adjust.
5
min
Article
2025-09-30
Sahm rules are meant to be broken
Fed easing is finally here and fundamentals remain favorable. But what about that election? Members of our Investment Strategy & Solutions Group offer their outlook, including their latest views on equities, bonds, and commodities.
12
min
Article
2025-10-31
Rate relief: Fed cuts half point, but says “economy is strong”
Our expert explains the Fed's bold rate cut and some key takeaways for investors.
3
min
Article
2025-09-30
Bonds in Brief: Making Sense of the Macro — August issue
What's driving global bond markets and what are the investment implications? Read the August issue of "Bonds in brief" for Wellington Investment Director Marco Giordano's monthly assessment of risks and opportunities within bond markets.
4
min
Article
2025-09-30
Time to capitalise on the evolving role of bonds?
We outline why we think the new economic era is elevating the role of bonds as a source of attractive and stable income, downside protection and portfolio diversification.
2
min
Article
2025-09-30
Bonds in Brief: Making Sense of the Macro — July issue
What's driving global bond markets and what are the investment implications? Read July's issue of Bonds in Brief for Wellington Investment Director Marco Giordano's monthly assessment of risks and opportunities within bond markets.
5
min
Article
2025-08-10
URL References
Related Insights
The real issue on rate cuts? Keep your eyes on the dot (plot)
Keep your eyes on the Fed's 2025 dot plot. The real story is where policy rates are headed, not just the next rate cut.
By
Brij Khurana