The economic expansion has advanced from the initial recovery, and the focus is now on metrics the Federal Reserve is looking at to gauge the health of the economy. Since the Fed’s dual mandate is to keep prices stable and maximize employment, we will focus on labor and inflation metrics, keeping in mind the broader economic impact as well. We created a Fed Monitor to track some of the data points that will impact the Fed’s decisions to tighten financial conditions. Additionally, we try to quantify the data and information outside of the dashboard to determine if the Fed is being more dovish than the data, and likely to be more aggressive in the future, or if they are being hawkish relative to the data, and likely to be more conservative in the future.

The Federal Reserve (Fed) increased the Fed funds rate from a range of 0.00% to 0.25% at the start of last year to a range of 4.25% to 4.50% by year end. This Fed rate hike cycle is one of the fastest in history, but the cycle may be nearing its end. The Fed is projecting that rates will rise just above 5% this year and Chair Powell continues to telegraph a higher for longer stance on rates until inflation returns to the long-term target of 2.0%. Based on the fed funds futures market, however, the bond market expects rates to end the year around 4.6%. That is still high, but lower than the Fed’s latest projection. The latest odds currently point to a 0.25% increase in the Fed’s funds rate at the February FOMC meeting. The Fed hiked rates by either 0.50% or 0.75% in the last six meetings. A downshift to 0.25% would give the Fed more time to see how the current level of rates is impacting the broader economy.

Recent data would justify a slowdown in rate hikes. Within the labor market, average monthly jobs growth remains at a healthy level, though the pace of nonfarm payroll expansion is slowing. In the first quarter of 2022, the labor market expanded by an average of 539,000 jobs per month, before slowing to an average of 247,000 new jobs per month in the final quarter of the year. The pace of wage growth also remains at a strong level compared to pre-pandemic levels, but the pace of growth is slowing as well. The Fed’s primary focus at the moment is inflation and recent CPI reports are showing decelerating price pressures in the economy. Headline CPI inflation has slowed from a cycle peak of 9.1% year-over-year in June to 6.5% year-over-year in December. The underlying trend is even more encouraging based on how quickly inflation is decelerating in recent months. For example, the consumer price index grew at a rate of 11.2% annualized in the first half of 2022. The pace slowed substantially in the second half of the year to 1.9% annualized in the final six months of the year.

The Fed-O-Meter dial will remain slightly left of center. The Fed will likely slow the pace of rate hikes at the next FOMC meeting to 0.25%. Recent data on inflation and the labor market is indicating that a pause is getting closer. The trend of high inflation is shifting to disinflation, and we expect more good news on the inflation front in 2023.