Federal Reserve under pressure to back up hawkishness with rate projections
Federal Reserve officials are under pressure to prove they’re serious about stamping out elevated inflation by backing up their aggressive rhetoric with a new batch of interest rate projections to be released this week.
After its two-day policy meeting on Wednesday, the Federal Open Market Committee is expected to raise interest rates by at least 0.75 percentage points for the third consecutive time as it tries to slow down the overheated US economy.
The decision, which would lift federal funds rates to a new target range of 3 to 3.25 percent at the very least, will be accompanied by a new “dot plot” that aggregates officials’ forecasts for interest rates through the end of 2025. .
“The message should be that they don’t see the end of the tunnel in terms of rate hikes,” said Ethan Harris, head of Global Economics Research at Bank of America. “It’s less about how big the price movements will be, but about how sustainable they are.”
The new set of projections, the first since June, will also include officials’ estimates for inflation, unemployment and growth.
Harris said the Fed’s June forecasts were “not plausible”. Those forecasts indicated that the Federal Reserve was confident of achieving a “soft landing,” bringing inflation under control without causing significant economic damage.
According to economists’ forecasts, the dot plot is expected to predict a more aggressive monetary policy throughout this year and possibly through 2023.
Barbara Reinhard, head of asset allocation at Voya Investment Management, said: “The dot plot will have to show that once they raise rates to their terminal level, they will leave them there.”
The terminal level refers to the point where interest rates will peak in the Fed’s campaign to tighten monetary policy, the most aggressive since 1981.
The median forecast for the key rate is expected to rise to about 4 percent in 2022 and peak even higher in 2023. In June, officials predicted the fed funds rate would reach 3.4 percent by the end of the year and 3.8 percent in 2023, before declining in 2024.
Economists expect the inflation forecast to rise marginally in the near term and officials will recognize more directly that growth and jobs will take a bigger blow than they predicted at the start of the summer.
At the time, they estimated that the unemployment rate would rise to 4.1 percent by 2024. It currently hovers around 3.7 percent and is expected to exceed 4 percent next year, according to a recent Financial Times survey of top economists.
The main concern is that supply constraints will continue to fuel inflation, meaning the Fed will need to do more to contain it.
“Housing and labor supply are constraints that will not be temporary, and they create much more distance for the Fed to travel,” said Betsy Duke, former central bank governor. Bringing inflation down to 4 percent could happen “pretty easy,” she added, but it could be “much harder” to get it below 3 percent.
Many economists are warning that the Fed’s credibility is at stake, especially as some question its determination to put enough pressure on the economy to stamp out inflation.
Fed Chairman Jay Powell attempted to allay those concerns last month when he delivered his most aggressive message yet at the annual central bankers’ symposium in Jackson Hole, Wyoming.
Some economists argue that the most effective way to bolster the Fed’s resolve to ease price pressures is for the central bank to spend a full percentage point rate hike this week, especially in light of the alarming inflation data from August.
However, according to CME Group, traders of futures contracts with fed funds have priced in the probability of that outcome at just 20 percent. Most economists, on the other hand, expect the string of major rate hikes to be extended beyond September. The implementation of a fourth consecutive 0.75 percentage point increase at the November meeting is at stake.
Raghuram Rajan, the former governor of the Reserve Bank of India, said the Fed would face a major test if inflation remained high while clear “signs of slump” emerged in the wider economy.
“It becomes a much more problematic situation when the economy is very weak, but you still see reasons to actually do more,” he said. “Then you discover the true character of the central bank.”