Wednesday, February 1, 2023
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Fed: as Fed plans to ‘lift and hold’, new forecasts could show cost

U.S. Federal Reserve officials announced plans to raise interest rates by half a point at their meeting this month, and while that would be a step down from recent rate hikes, new forecasts released at the time could show the discount rate is approaching levels that last times observed on the eve of the 2007 financial crisis.

What’s more, in a forecast that could build on market expectations of rate cuts by the end of next year, new projections from the 19 US central banks could well show the federal funds rate to remain at this elevated level until at least 2023.

The updated forecasts will give Fed officials a new chance to show how their “raise and hold” strategy is expected to work in terms of the final overnight discount rate level, as well as the progress of growth, inflation and unemployment in what they hope is a sustainable economy.

The rate-setting Federal Open Market Committee meets Dec. 13-14, ending a volatile year in which the central bank responded to the fastest spike in inflation since the 1980s with the fastest hike in interest rates since to try to offset it. This aggressive response sent shock waves through the financial system, which at one point erased nearly $12 trillion in US stock market value and most recently raised mortgage rates to 7% for a population accustomed to cheap money.

Equity markets have rallied lately and soared this week when Fed Chairman Jerome Powell said in what was probably his last public speech before the meeting that the Fed was poised to slow down after a string of four consecutive three-quarter-point rate hikes. a potentially uncomfortable outcome for the Fed chairman, who wants to maintain tight financial conditions and focus public expectations on the battle against inflation.

But Powell was also forthright about the compromise. Even if the central bank starts to move in half-point or quarter-point increments, the discount rate is moving up to a yet-to-be-determined “properly restrictive” stop point, and officials intend to leave it there “for the time being.”

Fed officials from San Francisco Fed President Mary Daley to St. Louis Fed President James Bullard, often at opposite ends of recent policy debates, have both discussed rates that could rise above 5% next year. The last time the Fed’s discount rate rose above this mark was between June 2006 and July 2007, at the onset of the financial crisis and recession of 2007–2009, when the federal funds rate peaked at 5.25%.

If there is concern about crossing this line, Fed officials have not spoken about it. New York Fed President and FOMC Vice Chairman John Williams recently said he expects a “restrictive” interest rate “until at least next year.”

INFLATION ‘TOO HIGH’
Powell, in a lengthy conversation at the Brookings Institution this week, outlined what could indeed be a long transition for the Fed and the US economy into a world of slowly declining inflation, high interest rates and potentially chronic labor shortages.

To slow the pace of price increases, he says, it is clear that energy needs to be pumped out of the labor market, where demand for workers still far outstrips the number of people willing to take jobs – an imbalance built into US demographic and immigration policies. and exacerbated by the pandemic. The new Round of Economic Forecasts will include estimates of how much more losses the Fed thinks it will have to pay in terms of rising unemployment and slowing growth as its policies begin to bite.

Data released Thursday showed the Fed’s preferred inflation rate of 6% in October, down from September’s 6.3% and the lowest this year, but still three times the Fed’s 2% target.

“Significantly more evidence will be needed to make sure that inflation is actually declining. By any measure, inflation remains too high,” Powell said.

Friday’s employment data will estimate wage growth for November, another big piece of information for policy makers who believe prices are unlikely to fall until job and wage growth slows.

The economy added an average of 407,000 jobs per month this year. While that fell below 290,000 from August to October, and analysts expect only 200,000 new jobs to be added in November, it is still above the 183,000 added monthly in the decade before the pandemic.

FORECASTS ARE PERFECTLY EXCELLENT
The Fed’s forecasts have changed throughout the year to match reality. As of last December, officials were forecasting their discount rate to be just 0.9% by 2022, with their preferred rate of inflation falling to 2.6% — an implicit bet that inflation would partly ease on its own. The highest individual federal funds forecast was just 1.1%.

They were wrong four times. With a half-point increase expected at the next meeting, the discount rate will be in the range of 4.25% to 4.5% by the end of the year.

This week, Powell acknowledged the difficulty of forecasting in an environment still shaken by the pandemic and its aftermath.

But there is no other choice either, as the central bank ends its rampant pursuit of “early” rate hikes to tighten borrowing and lending conditions—the mechanism by which the Fed attempts to change the course of the economy—and begins, as Powell described it, to “feel” the way to stop.

As of September, the Fed’s narrative still included a favorable outcome to continued growth, solid progress on inflation, and less than a percentage point rise in the unemployment rate to 4.4% at the end of next year from the current 3.7%. what some people think. called “perfect disinflation,” which doesn’t cost much to the real economy.

The federal funds rate was projected to end 2023 at 4.6%.


According to Powell, it should be “somewhat higher.” Upcoming forecasts will show what the final destination may be in sight, as well as give a more accurate estimate of the possible costs.

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