By Howard Schneider
WASHINGTON (Reuters) – The Federal Reserve, after chasing inflation for much of the year, will look to 2025 in new forecasts this week that will fully show the depth and length of economic “pain” that policymakers expect. necessary to stop the current rise in prices.
The tale so far is not pretty.
The pace of rate increases, which is on the Fed’s preferred metric of more than three times its 2% target, has hardly budged in the face of the fastest set of US interest rate increases in nearly 30 years.
The forecast, due to be published alongside the Federal Reserve’s latest policy statement at 2PM ET (1800 GMT) on Wednesday, will show how strongly US central bank officials feel the need for interest rates to rise to respond to a wave of inflation, and what economic cracks are. which they are doing. Look at the outcome in terms of slower growth or higher unemployment.
Hopes of a ‘soft landing’, marked by inflation slowing towards the 2% target without a recession, may not fade: Policymakers are unlikely to expect outright deflation even as forecasts compiled in September hold out for an additional year, in this even year 2025.
However, outside the Fed, there is a growing sense that the path to a soft landing is unlikely. Some analysts estimate that the unemployment rate, which stood at 3.7% in August, may need to rise to 7.5%.
Traders in the Fed’s overnight interest rate contracts expect this overall rate to end between 4.25% and 4.50% – two percentage points higher than it is now and a level last seen in late 2007.
Krishna Guha, vice president of Evercore ISI, wrote last week that “the probability of a soft landing decreases materially” after US inflation data for August showed just how much price hikes will continue. “Even assuming…that inflation can still be brought down…without a proper recession, the data and the response it would trigger greatly increases the risk that the Fed will end up badly overrun and cause a recession anyway.” The interest rate may be as high as 5.00%.
end in sight?
The updated economic forecast will give the clearest indication yet of Fed policymakers’ sense of the rate end point, and key information for investors trying to value assets or home buyers wondering what the cost of a mortgage next year.
Some officials have recently shied away from discussing the issue in detail, fearing setting expectations and then having to change the situation. However, the new forecast will include anonymous estimates from each official of where the policy rate should be at the end of 2022 and the following three years. The so-called “point chart” estimates from the seven members of the Fed’s Board of Governors and 12 regional bank chiefs also include expectations for unemployment, inflation and economic growth.
As long as inflation continues to move sideways rather than downward, they face the dilemma of raising interest rates to higher levels than currently expected, or hope that the increases already reported will eventually do the job.
Graph: Price hikes and sideways inflation https://graphics.reuters.com/USA-FED/INFLATION/gkvlgnaywpb/chart.png
Patience or the final run?
The bias may now be towards patience. A three-quarter percentage point rate hike on Wednesday, which markets are widely expecting, would be the third “unusually large” increase in a row. At one point, officials said they would slow the pace of assessment of how the economy would respond to sharp rises in borrowing costs.
“The $20 trillion economy is not flipping on a dime,” Carl Ricadona, chief US economist at BNP Paribas (OTC :), said on a call with reporters last week. Although inflation is “flat,” he said, “pot is already being drained,” an old metaphor for rate hikes by the central bank that is making financial conditions tighter for homeowners, businesses and investors.
“It was a pretty strong punch, so it will take some time for the effects to fully seep out. But monetary policy is heading into restricted territory.” Some evidence of that is already on the horizon, with the 30-year average flat mortgage rate hitting 6% last week, having doubled in one year, and US equity investors battered by a bear market.
The question for Fed policy makers is just how “tight” rates should be to control inflation, and how they will know they have reached that point given the effect of rate hikes may not be felt for several months.
The forecast released three months ago charted a pretty flat trajectory, with next year’s policy rate going to end at around 3.8% and inflation declining on the Fed’s preferred measure to around 2.6%.
Graphic: The Federal Reserve’s last three inflation periods https://graphics.reuters.com/USA-FED/RATES/klpykareypg/chart.png
The 1.2 percentage point difference between the two, the so-called “real” or inflation-adjusted federal funds rate, showed the Fed acquiescing in the need for tighter policy. Anything more than about half a percentage point is considered restricted.
But this slight pressure on the brakes was seen as enough to bring down inflation, with the unemployment rate expected to rise to just 3.9% in 2023 and to 4.1% in 2024, while GDP growth remained at 1.7%, close to the Federal Reserve. . It is considered as a long term trend.
However, disappointing progress on inflation since then prompted Federal Reserve Chairman Jerome Powell to say last month that price control means a “sustainable period of below-trend growth” and a “soft” labor market – a sign that the upcoming outlook may They at least show a bumpy descent if not a complete crash.
At the very least, the data over the summer consumed months more than the hour Powell said was “sounding” toward the day when price and wage increases become self-enhancing, public confidence in the Fed is eroded, and the central bank is forced into some sort of shock tactic that Aimed at causing a sharp economic downturn.
That moment may not be here yet. Household and market measures of inflation expectations, important to how the Fed views its likelihood of success, have remained in check — and recently declined in two important surveys.
But eventually inflation will have to act until the Fed changes course.
June’s forecast of 5.2% inflation by the end of this year is likely to be revised upwards, measures of inflation persistence have grown, and policymakers have made clear they will not change course easily.
After waiting to start raising interest rates, only to see inflation accelerate, “the consequences of being fooled into a temporary dip in inflation may now be greater if another miscalculation damages the Fed’s credibility,” Fed Governor Christopher Waller said recently.
Charts: Prices chase inflation https://graphics.reuters.com/USA-FED/INFLATION/xmvjoaxxopr/chart.png