Fed three-quarter point hike expected, but forecast is main focus

The Fed will accept a recession in the name of fighting inflation

It’s not what the Fed does, but what it says it might do in the future that will be most crucial when the central bank wraps up its two-day meeting on Wednesday.

The Fed is expected to trigger another three-quarter rate hike, the third in a row. It will also release quarterly forecasts on inflation, the economy and the future path of interest rates on Wednesday at 2 pm ET.

The Fed’s projections are always important, but this time they are even more important because investors have been trying to play how high will raise interest rates and how much officials hope their actions will hurt the economy.

Fed Chairman Jerome Powell speaks at 2:30 p.m. ET and is expected to stress that the central bank will do whatever it takes to fight inflation and is unlikely to reverse its rate hikes in the short term.

Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington on July 27, 2022.

Elizabeth Franz | Reuters

“I think he put a bulletin board behind him that says ‘Inflation needs to come down,'” said Rick Rieder, BlackRock’s chief investment officer for global fixed income. “I think he’s going to talk tough.”

The new forecasts also come as the central bank moves into a rate-hiking zone that some economists say will be tighter and could have a more serious impact on the economy.

“It’s not what they do, it’s what they say. This is our first real tightening roadmap. We had theoretical roadmaps up until now, but from the Fed’s point of view, they’re crossing over into a tightening world. That it’s an important thing,” said Diane Swonk, chief economist at KPMG.

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The Fed has been raising rates for seven months and will now move its target rate above what had been considered the neutral zone when inflation was low. Neutral is considered to be the interest rate level at which Fed policy is no longer easy but still not restrictive. The Fed has viewed 2.5% as neutral, and if it rises three-quarters of a point, the fed funds rate will be in a range of 3% to 3.25%.

‚ÄúThis is really moving into tight monetary policy territory. We will move into no man’s land,” Swonk said. “We haven’t really tightened policy to fight inflation since the early 1980s. Their goal is a prolonged slowdown that brings inflation down slowly and only gradually raises the unemployment rate. Whether they succeed is another problem.”

Rate expectations jumped

Economists have been raising their forecasts on how high they expect the Fed to take the fed funds target before stopping hikes. That level is called the terminal rate.

Fed tightening expectations rose sharply last week, after a surprisingly positive consumer price index report for August. Federal funds futures were trading Monday at a terminal rate of 4.5% in April, down from 4% before the inflation report was released last Tuesday.

the CPI rose 0.1% in August, while economists expected a decline.

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“The CPI number last week caused a lot in terms of revision of market prices”, said Peter Boockvar, chief investment officer at Bleakley Advisory Group. Stocks have been selling off and bond yields soared after that report, with some short-term Treasury yields topping 4%. the 10-year Treasury yield rit rose to 3.59% on Tuesday, the highest since April 2011.

The Fed’s latest forecast, in June, estimated the terminal federal funds rate to be 3.8% in 2023.

economists now expects the Fed to raise the terminal rate forecast above 4%. Citigroup economists said they could even see a scenario where it could top 5% if the Fed needs to be more aggressive in its fight against inflation.

Goldman Sachs economists, in a report, said they expect Fed officials’ median forecast to show the funds rate at 4% to 4.25% by the end of the year, with another increase to a maximum of 4, 25% to 4.5% in 2023. Then expect one cut in 2024 and two more in 2025.

labor market pain

Swonk expects some of that pain to show an increase in the unemployment rate above 5% by the end of next year.

In June, the Fed forecast that the unemployment rate would be 3.7% this year, the same level as August. Fed officials also expected unemployment to rise to 3.9% in 2023 and 4.1% by 2024.

“I think they’re going to be a little light on the unemployment rate. I agree that they really have to raise the unemployment rate to really make progress with inflation,” said Jim Caron, director of Morgan Stanley Investment Management. Macro strategies for global fixed income. “They’re in the ‘We don’t have to do that’ camp.”

Why is everyone so obsessed with inflation?

Caron said the Fed’s rate hike is a process that will increase the risk of recession.

“As recession risks increase, inflation risks are reduced because it’s about reducing demand in the economy,” he said. “The sacrifice is slower growth in the future.”

There are some investors betting that the Fed will raise rates by a full percentage point, but most economists see a 75 basis point hike. One basis point is equal to 0.01 of a percentage point.

“I think 75 basis points is pretty much built into the pie,” Caron said. “Now, it’s going to be about what they actually tell us… They don’t want to do future guidance, but the reality is that people will continue to look to them for future guidance.”

‘Out-hawk’ the market

Powell has taken a more aggressive tone. he gave her a short and direct speech at the Fed’s annual Jackson Hole symposium in late August, where he warned that the economy could suffer from a Fed tightening. The chairman stressed that the Fed will use economic data to guide policy, also stressing that policymakers will keep rates high until inflation decreases.

“I think the message will be very much the same as Jackson Hole,” said Michael Gapen, chief US economist at Bank of America. “It will be about making the policy restrictive, getting it to be there for a period of time with the overall goal being price stability.”

Caron said it’s possible Powell could sound inadvertently bearish because the Fed has leaned so far.

“I think a 75 basis point move is pretty aggressive, the third in a row,” Caron said. “I don’t think they have to work very hard to ‘beat’ the market.”

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