The Fed Raises Rates by 0.75 Point, Flags Higher Peak Than Expected
The Federal Reserve on Wednesday decided to raise interest rates by 0.75 percentage point and signaled rates may go higher than investors have anticipated as the central bank battles decades-high inflation.
The latest increase brings the Fed’s main policy rate up to a range of 3%-3.25%, the highest since early 2008. It comes after recent consumer price inflation data came in hotter than expected, surprising somes and showing that inflation has become sticky , widespread, and more a result of strong demand than supply problems. Leading up to the August CPI report earlier this month, many on Wall Street had expected the Fed to slow its pace in September, raising rates by a half point.
More important than the latest rate increase is the message the Fed sent about where rates are heading. The bank released an updated summary of its economic projections, or SEP, a quarterly report signaling where officials see interest rates, inflation, unemployment, and gross domestic product heading through 2025. A so-called dot chart within the document suggests most officials see rates rising above 4.5% next year, with six of them forecasting a terminal rate of 4.9%. Heading into the meeting, markets expected rates to peak at 4.5% in March before falling back to 4% at the end of 2023. Most officials expect a policy rate of 3.9% or lower by December 2024.
Taken together, the new dots signal the Fed has grown more hawkish since June and that it intends to leave relatively high rates for longer than strategists and investors have expected. They also imply another 1.25 percentage points in rate increases this year, meaning another 0.75 point hike in November is likely, to be followed by a half-point increase in December.
“My main message has not changed at all since Jackson Hole,” Fed Chairman Jerome Powell said during his press conference, nodding to a short speech he gave in August that struck investors with its decidedly more hawkish tone compared with prior public appearances. “We will need a period of growth below trend and some softening in the labor market,” Powell said, adding that “we’ve just moved into the very lowest level of what might be restrictive. There is a ways to go.”
Still, the new terminal rate forecast falls short of some economists’ expectations. Matthew Luzzetti, chief US economist at Deutsche Bank, says rates will have to hit 5% before the Fed can begin cutting.
Alongside the projections of higher interest rates for longer came updated, gloomier economic forecasts. Officials raised their projects for the unemployment rate to 4.4% for 2023 and 2024, up from prior estimates of 3.9% and 4.1%, respectively. A jobless rate of 4.4% translates to an increase of roughly 1.2 million people from current levels, notes Omair Sharif of Inflation Insights.
“The short-run cost via a higher unemployment rate, which is certainly meaningful to people who lose their jobs, is necessary to bring inflation down so that the economy can reap the longer-term benefits of price stability,” Powell said.
As Piper Sandler head of global policy Roberto Perli put it, the new unemployment projects are a giveaway that the Fed thinks a recession is coming. Perli notes that there has never been a situation where the unemployment rate increased more than about a half percentage point without a recession.
Still, officials continue to predict economic growth in 2023 and 2024 that is only slightly weaker than they last projected. That conflicts with Powell’s messaging and the reality of unemployment, and it is a rising tacit signal that officials still believe a so-called soft landing is possible despite more aggressive policy tightening.
Some economists say the Fed’s forecasts are still too rosy. RSM chief economist Joseph Brusuelas recently told Barron’s That his modeling suggests unemployment will have to rise to at least 6% for inflation to fall back to the Fed’s 2% target. Powell on Wednesday reiterated the Fed’s commitment to the longstanding inflation target, an attempt to beat back growing expectations that the bank will raise its inflation target to 3% in an effort to limit unemployment and because some of the factors behind rising prices aren’t sensitive to interest rates.
The Fed’s new inflation forecasts show officials expect the personal consumption expenditure index to end the year at a 5.4% annual rate, down from a current 6.3%. They see that rate falling to 2.8% next year and 2.3% in 2024, reflecting only small upward revisions to last quarter’s forecasts.
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