The Federal Open Market Committee is widely expected to raise rates by 50 basis points and bring its benchmark target rate to a range of 4.25% to 4.5%, the highest since 2007. — Bloomberg
NEW YORK: The US Federal Reserve is poised to moderate its aggressive tightening, while signalling that interest rates will ultimately go higher than previously forecast.
The tricky part for chairman Jerome Powell will be convincing investors that this isn’t a dovish pivot and that officials won’t prematurely end their assault against inflation that’s running three times higher than their 2% goal.
The Federal Open Market Committee (FOMC) is widely expected to raise rates by 50 basis points and bring its benchmark target rate to a range of 4.25% to 4.5%, the highest since 2007.
Fresh quarterly economic projections released after the meeting will also shed light on how much further policymakers expect rates to go.
Bloomberg polled economists, and the median estimate is 4.9%, after Powell stated that rates will need to be raised higher than previously anticipated.
That implies the FOMC is stepping down to a 25-basis-point moves in February and March and then putting policy on hold. Investors see things the same way, according to current pricing in interest rate futures markets.
Consumer price data released on Tuesday suggests the worst of US inflation may have passed, making it easier for officials to downshift to a smaller rate increase this week.
But Powell could use his press conference to remind the public that officials are not going to let up until inflation is clearly on a path back down to 2%.
“All eyes will be on the dot plot and the conference and what Powell will be telling us in terms of the path for interest rates going forward,” said Lydia Boussour, senior economist for EY Parthenon, referring to the quarterly projections for rates displayed as a chart of anonymous dots through 2025 and in the longer run.
At their September meeting, Fed officials saw rates reaching 4.6% by the end of next year. But policymakers say those expectations have since moved up following economic data showing that while inflation is easing, it remains stubbornly high.
Officials also say the labour market is still out of balance, with demand for workers exceeding labour supply and wage growth not letting up.
The projections will offer an insight on policymakers’ latest views on where they expect rates to go. But the Fed chief is unlikely to commit to a specific path, preferring to keep his options open, said Michael Pugliese, an economist at Wells Fargo and Co.
“I think they’ll preserve flexibility,” he said.
The rate projections could offer clues on how soon officials expect to pause the rate increases.
For example, a more modest increase in the terminal rate may suggest that officials could stop hiking rates as soon as March, while a higher peak may suggest that rate increases could continue further into next year, said Tim Duy, chief US economist for SGH Macro Advisors.
But he said it will also be important to hear from Powell about how officials will know that it’s time to pause the rate increases or if they should keep hiking.
“They’ve been edging closer to something that they think is a terminal rate and that appears to be something near 5%,” said Duy. “What conditions would sort of reinforce that?”
One key phrase to watch for in the FOMC statement is whether officials continue to say that “ongoing increases in the target range will be appropriate” to bring rates to a level sufficiently restrictive to reduce inflation.
Removing the word “ongoing” could send a dovish signal and suggest that the Fed is likely to pause rate increases in March, sooner than expected, according to Roberto Perli and Benson Durham of Piper Sandler and Co.
However, Fed officials could also decide to keep the “ongoing increases” wording in the statement for the remainder of the hiking cycle to avoid sending a signal that could ease financial conditions, said Derek Tang, an economist with LH Meyer.
“There’s little cost to them to keep ‘ongoing increases’ in there until the first meeting with no hike,” Tang wrote in a note.
The projections will also reveal what officials expect to see from the US economy in terms of growth, the unemployment rate and inflation.
Forecasts showing that officials now expect it to take longer for inflation to come down to their target could help justify their higher interest rate projections, said James Knightley, chief international economist for ING.
Policymakers could downgrade their outlook for next year, projecting lower economic growth that is closer to zero and a higher unemployment rate that is approaching 5%, up from the current rate of 3.7%, said EY Parthenon’s Boussour.
“I think there will be that idea coming out of the new projections that the Fed is ready to tolerate some more economic pain in order to restore price stability,” she said.
Even if officials present a base case that avoids a recession, the direction in which those indicators are headed can offer insight on how officials view recession risks, said Pugliese.
Powell could use the press conference to tell the public that officials believe there is still a path, albeit a narrower one, to achieving a soft landing, where they succeed in bringing inflation down while minimising the pain for households, said Knightley.
“I think the Fed will be saying that recession is a possibility, but it’s not a base case,” he said. — Bloomberg
