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May 2023

The Fed Has a Tough Job as the Economy Is in Transition

Key Points

  • We believe the Fed will keep the fed funds rate at the 5.125% level well into 2024
  • This roller coaster ride of data is a classic case of an economy in transition
  • Throughout this, the Fed has remained singularly focused on bringing down inflation

It already has been a tumultuous year for the Fed, and it is only about one-third over. As 2023 came out of the starting gate, economic releases showed the economy had weakened in December, brought on by the Fed’s restrictive monetary policy and bad weather. 

The data implied the Fed would not have to aggressively raise interest rates this year. Then, in February, as the January economic data was being released, it showed some sectors were roaring back.

First, the labor report had a blockbuster gain, with nonfarm payrolls increasing by 517,000 (it has since been revised to 472,000), reversing a long-standing downward trend (chart 1). The unemployment rate was 3.4%, a 54-year low. Then retail sales jumped 3.0% for the month, much stronger than the 2022 average monthly gain of just 0.5%. This showed that the consumer remained resilient despite higher interest rates. Finally, the inflation report showed that the deflationary trend was stagnating. As a result, the financial markets believed the Fed needed to increase interest rates more than was expected just a month earlier.

Then came March. The economic releases showed a more moderate rate of growth. This roller coaster ride of data is a classic case of an economy in transition. Although the pace of economic growth was on a downward trajectory, some areas were still affected by positive influences from the ripple effects of the pandemic and the government’s policy response.

The crosscurrents are extreme. On the weaker side, some critical sectors of the economy have responded to higher interest rates and the change in demand as consumers return to their pre-pandemic habits. Manufacturing and housing are showing moderate growth or declines.

Throughout this, the Fed has remained singularly focused on bringing down inflation. It has raised the federal funds rate at one of the fastest paces in recent history (chart 2).


The median level now stands at 5.125%, a full five percentage points higher than it was when the Fed undertook its interest rate increases just over a year ago. The monetary policy changes since last March are beginning to impact the economy. The lags can be long, variable and highly uncertain. The Fed appears to be taking a pause in interest rate increases. It needs time to observe the impact of the cumulative increase in interest rates on the economy. We believe the Fed will keep the federal funds rate at 5.125% throughout the year.

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