The Federal Reserve’s release of its latest economic outlook on Wednesday continued what could be called its gradual increase to meet inflationary realities. It has taken far too long, but central banks are getting closer to the degree of monetary policy tightening needed to bring inflation down.
The Federal Open Market Committee raised its target for fed funds by another 75 basis points to between 3% and 3.25%. It’s the third consecutive 75-point hike. More significant is the forward guidance in its average economic projections that rates could rise another 125 basis points this year and higher than in 2023. This suggests a so-called terminal rate during this tightening cycle that is higher than 4.5% and could be 5 % next year.
While the pace of rate hikes has been brisk in recent months, the story of the past year is how long it took the Fed to act. The Fed’s median projection for its target rate for 2022 has risen from 0.9% last December to 1.9% in March, 3.4% in June and now 4.4%. That rally reflects the Fed’s historic misjudgment of how high inflation would rise and how persistent it would prove to be.
One cost of delay will be slower economic growth as the Fed has to tighten more than it otherwise would have. The median forecast of board members and bank presidents for economic growth this year is now just 0.2%, down from 1.7% in June, 2.8% in March – and 4% last December, if you can believe them that only nine months ago. The GDP growth forecast for next year is still a meager 1.2%. In short, we are in for stagflation.
Even this may be optimistic if one considers Milton Friedman’s admonition that monetary policy works with long and variable lags. That means today’s tightening may not have the biggest impact until late 2023 or into 2024. Equity markets agreed with the pessimists on Wednesday as they sold off late and bond yields retreated from intraday highs.
Rumors of looming recession are everywhere, but the Fed still has inflation falling rapidly in 2023 and unemployment rising only modestly to a peak of 4.4% from 3.7% today. That’s about as soft a landing as anyone could expect. That assumes there are no financial surprises along the way, which there always are, as rising interest rates beat up the overleveraged.
Chairman Jerome Powell would no doubt count this Fed forecast as a victory if he can pull it off. Given the deep inflationary hole we’re in and the lack of any pro-growth policies from the Biden administration or Congress, that’s probably the best we can hope for.
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Published in the print edition on September 22, 2022.