Thursday, December 15, 2022
Slower Growth and Higher Inflation
As expected, the Federal Open Market Committee (FOMC) increased the fed funds rate yesterday by 0.50% and made upward revisions to both inflation forecasts and interest rate forecasts in the next few years. The target range is now 4.25–4.50%. This meeting signaled the beginning of a downshift in the pace of rate hikes, as the previous four meetings concluded with a 0.75% increase to the target rate. The Committee delivered a well-telegraphed move, barely changing any verbiage from the previous statement, and unlike the recent rate decision in the U.K., the FOMC was unanimous.
The FOMC released an updated Summary of Economic Projections (SEP) after this meeting and from all appearances, the Committee is more pessimistic about growth and inflation than they were in the September edition of the SEP.
The Committee downwardly revised growth forecasts for both 2023 and 2024 as high inflation is expected to weigh heavily on consumer spending. As inflation is expected to erode purchasing power, growth will likely stall next year. Short-term interest rates will likely be higher next year, as the Committee believes inflation will not come down as fast as projected in September. The Committee did not change the long-run estimate of the fed funds rate but the Committee revised up projections for fed funds in 2023 and 2024. A healthy minority of committee members are forecasting fed funds above 5.25%, creating a hawkish tilt to the overall forecast. In the press conference, Chairman Powell focused on the imbalances in the labor market, indicating that the job market is the linchpin for economic growth in the coming year.
The Fed is uncertain about the future path for inflation and therefore, has remained decidedly hawkish on short-term rates. However, the Fed has demonstrated a penchant for forecast revisions, so we should not be surprised if the Fed revises the expected peak fed funds rate as inflation, including the sticky components, starts to moderate. Looking ahead, investors need to watch the inflation path for non-housing core services, which is closely tied to labor market conditions.
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