The Fed’s Interest Rate Trajectory Is Clouded by Inflation and War

By Ruth K. Washington Last updated Nov 29, 2022

WASHINGTON, March 15 (Reuters) – The U.S. The Federal Reserve will provide new economic estimates this week that will illustrate how far and how fast policymakers expect interest rates to rise this year, in a first test of the influence of the Ukraine war and spiking inflation on the upcoming shift in U.S. monetary policy.

The Fed’s policy-making committee is likely to raise borrowing prices by a quarter-point at the end of its two-day meeting on Wednesday, setting the tone for the central bank’s response to a war-driven oil shock clashing with an end-of-pandemic economic recovery and robust consumer demand.

The most recent quarterly economic estimates, which will be released along with a policy statement at 2 p.m. EDT (1800 GMT) on Wednesday, will highlight what authorities expect in terms of key metrics such as GDP growth, inflation, and unemployment. Updated forecasts, in particular, will indicate how active authorities will be in raising interest rates, and whether this will threaten a predicted record-breaking run of low unemployment.

Fed Chair Jerome Powell will hold a press conference shortly after the papers are available to explain the meeting and the outlook.

As of December, policymakers anticipated a relatively benign battle with inflation that would necessitate only modest rate increases and no change to an unemployment rate expected to remain at 3.5 percent through 2024 – an employment outcome not seen since the early post-World War II boom in the 1950s.

This week’s meeting is “complex” by the need to respond fast to inflation, which is already at a 40-year high, but also by a desire to control prices without boosting the unemployment rate, according to Steve Englander, Standard Chartered Bank’s head of macro research for North America.

Fed policymakers forecast in December that raising the benchmark overnight interest rate, or federal funds rate, by three-quarters of a percentage point would be sufficient in 2022 to begin easing inflation back towards the 2% target.

Since then, price increases have increased – the Fed’s favoured inflation measure is now 6% – and the start of war in Europe has introduced a new set of threats. However, Englander believes that Fed officials will continue to be wary of adopting restrictive policies that could increase the likelihood of a recession and increased unemployment in the future years.

“We are not convinced by the ultra-hawkish arguments” that the Fed will raise rates at each of its remaining seven policy meetings this year, or that rates will need to become restrictive to win the inflation war, he added.

MESSAGE FROM THE HAWK

Englander believes the Fed will indicate rate hikes totaling 1.25 to 1.50 percentage points this year, which is less than many investors presently anticipate.

According to the median forecast of economists polled by Reuters, the Fed will raise the target federal funds rate from near-zero to a range of 1.25 percent to 1.50 percent by the end of 2022, representing a five-quarter-point increase.

Investors in futures contracts linked to the federal funds rate expect the Fed to raise borrowing costs at a little faster pace this year, with its policy rate hovering between 1.75 percent and 2.00 percent towards the end of the year.

Since the start of the COVID-19 pandemic, the Fed’s forecasts for the US economy have been out of step with reality.

The unemployment rate fell faster, growth increased faster, and, perhaps most importantly, the rate of inflation soared much above expectations.

As the Fed’s estimates caught up with the economy, so did the policy outlook, with officials pencilling in more and more rate hikes in the coming year and beyond.

Nonetheless, as of December, they clung to the promise of a “soft landing.”

For inflation to reduce, the federal funds rate would only need to climb to roughly 2.10 percent by the end of 2024, a rate that is low by historical standards and loose enough to support economic growth above trend and the unemployment rate around 3.5 percent through 2024.

When the dust settles on Wednesday, things might not look so rosy.

“Growth and unemployment should be revised downward, while headline and core inflation (personal consumption expenditures) should be revised upward… We anticipate a hawkish message from Chair Powell, who will most likely emphasise the Fed’s commitment to price stability “Analysts at Bank of America said.

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