Fed expects to hike rates sooner than you think
The Federal Reserve plans to hike interest rates in 2023, according to new economic projections released by the central bank on Wednesday.
This contrasts sharply with the Fed’s previous forecast in March, in which the central bank predicted rates would stay close to zero for at least the next two years.
Some members of the Federal Open Market Committee – which decides central bank policy – are in favor of raising interest rates next year, according to projections.
The central bank also expects stronger growth, with real gross domestic product – the broadest measure of economic activity – up 7% in 2021, down from 6.5% in March projections.
But with stronger growth comes higher inflation. The Fed has raised its inflation forecast for 2021 by a whole percentage point to a whopping 3.4%, reflecting price increases across the spectrum for consumers and producers.
That’s well above the Fed’s target of around 2%. However, the central bank is still signaling confidence that this inflation surge will pass. The median expectation is that inflation will drop to just 2.1% in 2022, up slightly from the March projection. The forecast for 2023 inflation has barely budged. In its policy statement, the Fed again noted that “inflation has increased”, but stressed that this “largely” reflects transient factors.
Bottlenecks and supply chain shortages have driven inflation up in recent months. Companies are trying to keep up with demand, but Powell said it was unlikely to lead to its opposite – oversupply.
“The problem now is that the demand is very high, the incomes are high, people have money in bank accounts. The demand for goods is extremely high and it hasn’t gone down,” said Powell. “But in terms of over-correction, there’s a possibility on the other side of that that inflation could actually be quite low going forward. But that’s not where we’re focusing right now. . “
Powell said there was no reason to assume prices will stay high for long. If travel prices continue to rise, for example, people are likely to build new hotels. But when prices will return to a normal range remains uncertain, he said.
“We are by no means dismissing the possibility that this may turn out to be longer than expected, and the risk would be that over time this will start to affect inflation expectations,” said Powell.
If so, the Fed would go back to its toolbox to fix the problem, he said.
For now, the Fed will leave interest rates unchanged and continue its quantitative easing program, including buying at least $ 80 billion in Treasury securities and at least $ 40 billion in mortgage-backed securities. , according to its policy update Wednesday.
However, Fed Chairman Jerome Powell admitted this week’s policy meeting was “the meeting to talk about it”, referring to a statement he made last year that the central bank was not discussing not even the possible discussion to reduce asset purchases.
Labor market improvements
The Fed definitely feels better about the economy in the short term. But that’s not entirely true for the job market: the central bank’s unemployment rate expectations remained unchanged at 4.5% in its projections before dropping to 3.8% next year and 3.5% in 2023.
“We are on the road to a very strong job market,” Powell said at Wednesday’s press conference.
But he also acknowledged that it was difficult to say what labor market participation might look like after the pandemic, which forced some workers out of the labor market.
US stocks fell in response to the news and ended the day in the red. The Dow Jones closed 0.8% or 266 points lower, while the S&P 500 and Nasdaq Composite were down 0.5% and 0.2% respectively.
Higher rates are potentially bad news for futures stocks, as more expensive borrowing could undermine corporate results, ending the easy money policy of the past 15 months.
Shares have moved higher in recent weeks in anticipation of Wednesday’s Fed update. Investors had become more complacent, even as several inflation reports showed prices were rising more than expected, a big reversal from initial concerns about inflation.
Still, it would be good news for investors if the Fed largely stayed the course and kept rates near the lowest.
And that’s pretty much what the Fed did on Wednesday: rates remain ultra-low.