The Fed is expected to launch another rate hike of three-quarters of a point – its third in a row. He will also release new quarterly forecasts for inflation, the economy, and the future path of interest rates Wednesday at 2 PM ET.
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The Fed’s outlook is always important, but this time it is even more so because investors have been trying to manipulate how much the Fed will raise interest rates and how much officials expect their actions to affect the economy.
Fed Chairman Jerome Powell speaks at 2:30 PM ET and is expected to stress that the Fed will do what it takes to fight inflation and is unlikely to reverse higher interest rates anytime soon.
“I think he put a billboard behind him that says ‘inflation should come down,'” said Rick Rieder, chief investment officer of global fixed income firm BlackRock.
The Fed’s new forecast also comes with the central bank moving into a rate hike zone that some economists expect will be more restrictive and could seriously affect the economy.
“That’s not what they’re doing, that’s what they say. This is the first actual hardening roadmap. We have theoretical roadmaps so far, but from the Fed’s point of view, they’re crossing into a world of hardening. That’s important,” said Diane Sonk, chief economist at KPMG.
The Fed has raised interest rates for seven months now, and will now move its target rate above what was considered neutral territory when inflation was low. Neutral is the interest rate level where Fed policy is no longer easy, but not yet restrictive. The Fed considered 2.5% to be neutral, and if it increased by three-quarters of a point, the fed funds would be in the range of 3% to 3.25%.
“This is already moving into the territory of restrictive monetary policy. We will move into the no-man’s-land,” Sonk said. “We haven’t really tightened anti-inflation policy since the early 1980s. Their goal is a prolonged slowdown that leads to inflation coming down slowly and only gradually increasing the unemployment rate. Whether they get there is another problem.”
Price expectations jumped
Economists have ramped up their expectations of how high they expect the Fed to take the fed funds target before halting rate hikes. This level is called the final rate.
Expectations for Fed tightening increased significantly last week, after a surprisingly hot August consumer price inflation report. Monday’s Fed fund futures contracts were pricing in a final rate of 4.5% by April, up from just about 4% before the CPI release last Tuesday.
The CPI rose 0.1% in August, while economists had expected it to ease.
“Last week’s CPI number caused a lot in terms of market repricing,” said Peter Bokfar, chief investment officer at Bleakley Advisory Group. Stocks were selling, and bond yields rose after that report, with some short-term Treasury yields rising above 4%. The 10-year Treasury yield rose to 3.59% Tuesday, the highest level since April 2011.
The Fed’s latest forecast, in June, put the final federal funds rate at 3.8% in 2023.
Economists now expect the Fed to raise its final interest rate forecast above 4%. Citigroup economists said they could even see a scenario where the rate could rise above 5% if the Fed needs to get fiercer in its fight against inflation.
Economists at Goldman Sachs, in a report, said they expect Fed officials’ median forecast to show the funds rate at 4% to 4.25% at the end of the year, with another rise to a peak of 4.25% to 4.5% in 2023. Then they expect that. cut in 2024 and two more in 2025.
Labor market pain
Swonk expects some of those afflictions to show a jump in the unemployment rate to over 5% by the end of next year.
In June, the Fed expected the unemployment rate to be 3.7% this year, the same level as in August. Federal Reserve officials also expected the unemployment rate to rise to 3.9% in 2023 and 4.1% by 2024.
said Jim Caron, head of investment management at Morgan Stanley Macro Strategies for Global Fixed Income. “They’re in a camp,” we don’t have to do that. ”
Caron said the Fed rate hike is a process that will increase the risks of a recession.
“By increasing the risk of a recession, you reduce the risk of inflation because it’s all about lowering demand in the economy,” he said. “Sacrifice is slower growth in the future.”
Some investors are betting that the Fed will raise interest rates by a full percentage point, but most economists expect an increase of 75 basis points. A base point is 0.01 percentage point.
“I think 75 basis points is put into the pie,” Caron said. “Now, it’s going to be about what they’re actually telling us… they don’t want to do future guidance, but the fact is that people are still looking to them for future guidance.”
Hawks in the market
Powell took a tougher tone this summer. He gave a short, direct speech at the Federal Reserve’s annual Jackson Hole seminar in late August, where he warned that the economy could be in pain from the Fed’s tightening. The Chairman stressed that the Fed will use economic data to guide policy. He also emphasized that the Fed would keep interest rates at high levels.
“I think the message will be very much like the Jackson Hole message,” said Michael Gaben, chief US economist at Bank of America. “It’s going to be about making the policy constraining, and achieving it for a while with the overarching goal of price stability.”
Caron said Powell may sound unintentionally pessimistic because the Fed tends to be very hawkish.
“I think the 75 basis point move is a monotonous hawkish move, the third in a row,” Caron said. “I don’t think they have to work very hard to ‘beat the market.