Wall Street analysts will be paying close attention to what Federal Reserve Chairman Jerome Powell said Wednesday about the central bank slowing rate hikes at its next policy meeting in December.
Fed officials have already indicated that they will raise the federal funds rate this week by 0.75 percentage points to a range of 3.75% to 4%. This would mark the fourth consecutive increase in the measure as they try to reduce inflation by slowing the economy. Some officials have signaled their desire to start tapering the rate hikes after this week and potentially hold off on rate hikes early next year so they can see the impact of their actions.
Those officials and a number of private-sector economists have warned of growing risks that the Fed will raise rates too much and trigger an unnecessarily sharp slowdown. By June, the Fed had not raised interest rates by 0.75 basis points, or 75 basis points, since 1994.
“They should think about calibration in this meeting. You’re trying to cool the economy, not freeze it,” said Diane Swonk, chief economist at KPMG.
Fed officials have been broadly supportive of raising interest rates this summer as they try to catch up. Inflation neared a 40-year high, but interest rates were close to zero by March. Debate over how much to raise rates could intensify as spending, hiring and investment are likely to be curbed. The fed funds rate affects other borrowing costs across the economy, including rates on credit cards, mortgages and auto loans.
“They need to slow down. Keep in mind that 50 base points is fast; 75 basis points is really fast,” said Duke University economist Ellen Meade, a former senior adviser to the Fed.
December would be a natural time to slow the pace of rate hikes, as officials can use new projections at that meeting to indicate they expect to reach a higher peak or terminal rate than they previously anticipated, he said. The debate over the pace of the hikes may obscure the more important one of how high rates will ultimately rise. “Going faster now is about increasing the terminal fare,” Ms Meade said.
But some analysts say it will be difficult for the Fed to reverse the pace of rate hikes in December, as they expect inflation to run hotter than other analysts forecast. Fed officials had expected inflation to ease this year, but that forecast has so far been misplaced. They responded by targeting a higher interest rate than they had forecast earlier in the year, resulting in a longer-than-expected 0.75 basis point hike.
At the September meeting, officials predicted they would have to raise rates to at least 4.6% by early next year. “If you have broad agreement on that and inflation continues to be higher than expected, it makes sense to hit that peak sooner,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.
Analysts at Deutsche Bank, UBS, Credit Suisse and Nomura Securities expect the Fed to follow this week’s rate hike by 0.75 basis points, with a similar increase in December.
Meanwhile, analysts at Bank of America, Goldman Sachs, Morgan Stanley and Evercore ISI see the Fed dialing back its December rate hike by 0.5 basis points.
Economic data released after the Fed’s September meeting is mixed. While domestic demand slowed and the housing market fell sharply, the job market remained strong and inflationary pressures remained high. Recent earnings reports showed strong consumer demand and price increases.
Officials will see two more months of economic reports, including hiring and inflation, before they meet in mid-December. “Even if Powell gives instructions at a press conference, it will not be a commitment. That’s because the decision needs to be informed,” Laurence Meyer, a former Fed governor who runs economic forecasting firm LH Meyer Inc., wrote in a recent report.
Some economists say the Fed will need to raise the Fed interest rate above 4.6% next year due to the persistence of higher rates in consumer spending and domestic demand.
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Strategists at FHN Financial expect the Fed to raise the policy rate to around 6% by next June. After this week’s hike, the Fed could do so without another 0.75 basis point rate hike.
“The obvious dilemma for financial markets is that many things can be right at the same time, and many of them are pulling in different directions. The Fed may slow in December, but then still reach 6% in our forecast,” FHN Financial’s Jim Vogel said in a note to clients on Monday.
The Fed fights inflation by slowing the economy through tighter financial conditions, such as higher borrowing costs, lower stock prices and a stronger dollar, which curb demand. Changes to the trajectory of expected rates, and not just what the Fed does at any given meeting, can affect broader financial conditions.
This year, many investors have been eager to interpret signs of a less aggressive pace of rate hikes as a sign that a pause in rate hikes is not far off, but a sustained market rally risks undoing the Fed’s job of slowing the economy.
Any discussion by Mr. Powell about how officials see the potential for a higher rate path could dampen any market euphoria about a slower pace of growth, economists said. “Now it’s about the destination, not the journey,” Michael Gapen, chief U.S. economist at Bank of America, said in a report on Monday.
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