Taking an Early Hike?

With the economy recovering and inflation on the rise, Fed officials now expect to raise interest rates in 2023, a year earlier than previously predicted.

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Key Points

  • As expected, the Federal Open Market Committee (FOMC) held the federal funds target rate range at 0% to 0.25%.
  • With the economy booming and inflation rising, Fed officials moved up their expected timeline for interest-rate hikes to 2023, a year earlier than previously projected.
  • Fed projections for 2021 showed improvement in GDP (from 6.5% to 7%) with no change to unemployment.
  • Inflation is now projected to be at 3.4% this year (a full percentage point more than just three months ago) before slipping back to 2.1% in 2022.

At their June meeting, Fed officials kept interest rates near zero, but moved up the expected timeline for rate hikes by one year, projecting two increases by the end of 2023. The Fed raised its inflation projection to 3.4% by yearend, a full percentage point higher than its estimate just three months ago. “Shifts in demand can be large and rapid,” Chairman Jerome Powell said. “Inflation could turn out to be higher and more persistent than we expect.” But Fed officials said they viewed the jump in inflation as transitory and expected it to drop to 2.1% in 2022.

June’s projections showed continued economic optimism by the committee for this year as GDP expectations were adjusted upward from 6.5% to 7%, and unemployment projections held steady at 4.5%. The committee expects that the pandemic-related factors weighing on employment growth should wane in the coming months with the continued distribution of vaccines leading to rapid growth in employment. Still, Chairman Powell warned that “the recovery is still in complete, and risks to the economic outlook still remain.”

Below are the language changes made in the Fed’s statement from April:

Here are the committee’s June projections for GDP, unemployment, inflation, and the federal funds rate for 2021:

The “Dot Plot” showed interest rates to remain at current levels for the next 18 months, as the median projections showed no change for 2021 and 2022. The committee did adjust their projections for 2023 though, as projections showed two potential increases in the year by the Fed. While all policymakers expect to keep the fed funds rate near zero through the end of 2021, seven officials saw rates increasing in 2022, while 13 saw a higher fed funds rate in 2023. Two officials actually projected a fed funds rate between 1.5% and 1.75% in 2023:

In Conclusion

After the Fed announcement, the 10-year Treasury ended the day higher by 6 basis points to 1.57%; short and long rates were mixed on the day:

Markets closed the day lower on the news that the Fed was expecting rate hikes in 2023, a full year earlier than previously predicated. (This all comes after the Producer Price Index (PPI), released Tuesday, rose 6.6% on an annual basis, the largest 12-month jump on record.)

The negative market reaction wasn’t just seen in the major indexes, but also in the number of stocks that fell. About 77% of the S&P 500 Index finished the day lower, potentially indicating investor concerns about higher yields and the impact of the Fed’s new projections on stocks. The Dow Jones Industrial Average and S&P 500 finished the day down at -0.77% and -0.54%, respectively.

Fed officials reaffirmed their stance that policy will remain highly accommodative, as any potential move to taper current purchases will be methodical, transparent, and communicated in advance, giving investors a chance to adjust expectations. The committee indicated it is confident and determined to achieve the2% average inflation goal and maximum employment, and it looks like the Fed believes we are on the right path to achieve this as the committee’s projections continue to show increased optimism for the U.S. economy.

Disclosures

This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. This commentary reflects the views of the portfolio managers at Pacific Asset Management as of June 17, 2021, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All materials are compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

All investing involves risk, including the possible loss of the principal amount invested.

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to the Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name.

Bloomberg Finance L.P. is unaffiliated with Pacific Life Insurance Company, Pacific Funds, their affiliates, their distributors, and representatives.

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