September Fed Meeting: Will Keep At It Until The Job Is Done  

The Fed rose the federal funds rate 75 basis points to a range of 3.0 to 3.25 percent. They expect to continue hiking aggressively at their meetings in November and December, 75 and 50 basis points respectively, to a year-end range of 4.25 to 4.5 percent. One more 25 basis point hike in 2023 will leave the terminal rate at a range between 4.5 and 4.75 percent. No interest rate cuts are expected until 2024, when they expect their preferred inflation gauge, the core PCE, to approach 2.3 percent, near their 2 percent inflation target. Plans for balance sheet reduction remain unchanged at a pace of $95 billion per month comprised of $60 billion of Treasury holdings and $35 billion of mortgage-backed securities.

Chair Powell expressed during the press conference that inflation remains elevated and broad. While he cheered about long-term inflation expectations remaining well-anchored throughout this inflationary period, he warned against complacency on the inflation front. Complacency can lead to entrenched inflation which poses significant risks to economic stability. Entrenched inflation negatively effects firm and individual psychology as participants begin to expect and accept higher prices for longer as the new norm. This would cause their behaviors to shift and leads to increased difficulties in hampering inflation in the future.  

The Fed is looking for compelling evidence of inflation returning to their target as the pace of future rate hikes depends on the temperature of future data releases. Chair Powell acknowledged that commodities may have peaked in price but also noted that while falls in gasoline prices are welcome, they remain high relative to historical readings. He also expressed that labor market cooling is needed to constrain inflationary pressures by reducing demand, the committee is expecting an unemployment rate of 4.4 percent in 2023, an increase from August’s 3.7 percent level. The committee’s goal is to keep policy sufficiently restrictive to return inflation back to 2 percent.

Chair Powell acknowledged that achieving a “soft landing” while restoring price stability is a challenge. Due to higher rates and tighter policy, weakness has been felt in business investment, in the real estate sector, and in exports while there’s been modest evidence of labor market deterioration. In an undesirable bear-flattener move, the yield curve inverted further to -51 basis points during the Fed meeting as the 2-year rose while the 10-year fell. The more the yield curve inverts, the stronger the signal that the U.S. economy can’t handle the monetary policy tightening that’s in the pipeline.

So what are the Fed’s projections for GDP? The Fed expects economic growth to accelerate from 0.2 percent in 2022 to 1.2 percent in 2023. I firmly disagree with this forecast but understand the motives for maintaining positive GDP forecasts, after all, negative ones would be forecasting recession. Furthermore, they’re expecting GDP growth to accelerate while they’re expecting the unemployment rate to rise, this seems inconsistent. Monetary policy operates with a lag and we’ve already noted significant economic weakness in various areas although we just started tightening in March. If the Fed is moving higher and tighter from here, how could economic growth strengthen while the labor market weakens? We’ll have to wait and see but my instincts would certainly compel me to take the under.