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Fed meeting focuses on the path ahead for interest rates

Fed meeting focuses on the path ahead for interest rates
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Wall Street analysts Wednesday will focus on what Federal Reserve Chair Jerome Powell says about whether the central bank could slow rate hikes at its next policy meeting in December.

Fed officials have already indicated they are likely to hike their benchmark federal funds rate by 0.75 percentage points this week to a range between 3.75% and 4%. That would be their fourth consecutive rise of this magnitude as they try to tame inflation by slowing down the economy. Some of the officials have recently begun to signal their desire to taper hikes after this week and possibly halt rate hikes early next year so they can see the impact of their moves.

These officials and several private sector economists have warned of growing risks that the Fed will hike rates too much and cause an unnecessarily sharp slowdown. As of June, the Fed had not raised interest rates by 0.75 points, or 75 basis points, since 1994.

“You need to think about calibration at this meeting. They’re trying to cool an economy, not freeze it,” said Diane Swonk, chief economist at KPMG.

Fed officials largely backed outsized rate hikes this summer because they wanted to catch up. Inflation is close to 40-year highs, but interest rates were held near zero until March. The debate over how much more rate hikes are needed could intensify if they reach levels that are more likely to restrain spending, hiring and investment. The fed funds rate affects other borrowing costs throughout the economy, including interest rates on credit cards, mortgages, and car loans.

Americans have accumulated more credit card debt than ever before. The WSJ’s Dion Rabouin explains the contributing factors and why it could cause problems for the US economy. Photo: Keith Srakocic/Associated Press

“You have to slow down. Let’s remember that 50 basis points is fast; 75 basis points is really fast,” said Ellen Meade, an economist at Duke University and the former senior adviser to the Fed.

December would be a natural time to slow the pace of rate hikes as officials at that meeting could use new forecasts to show they expect to hit a higher peak or terminal rate than they had previously anticipated, he said you. The debate is over the speed increases could obscure a more important question about how high interest rates will eventually go. “Going faster now means increasing the end rate,” Ms. Meade said.

However, some analysts say it will be difficult for the Fed to scale back the pace of December’s rate hikes as they expect inflation to continue running hotter than other analysts have predicted. Fed officials had expected inflation to fall this year, but so far that prospect has been in vain. They responded by targeting a higher Fed Funds rate than they forecast earlier in the year, prompting a longer-than-expected string of 0.75-point rate hikes.

Officials at their September meeting predicted they would have to raise the rate to at least 4.6% by early next year. “If you’re broadly in agreement on this, and inflation continues to be higher than expected, it makes sense to get to that peak sooner,” said Matthew Luzzetti, chief US economist at Deutsche Bank.

Analysts at Deutsche Bank, UBS, Credit Suisse and Nomura Securities expect the Fed to follow this week’s 0.75 point rate hike in December.

Meanwhile, analysts at Bank of America, Goldman Sachs, Morgan Stanley and Evercore ISI see the Fed slowing the pace of rate hikes in December with a 0.5 point hike.

Economic data released since the Fed’s September meeting has been mixed. While domestic demand has slowed and the housing market is in a sharp downturn, job market stayed strong and Inflationary pressures remain elevated. Recent earnings reports have shown strong consumer demand and price increases.

Officials will see two more months of economic reports, including hiring and inflation, ahead of their mid-December meeting. “Even if Powell provides guidance at his press conference, it will not involve any commitment. That’s because the decision must be driven by data,” wrote former Fed Governor Laurence Meyer, who runs economic forecasting firm LH Meyer Inc., in a recent report.

Some economists say the Fed will need to raise interest rates above 4.6% next year as consumer spending and domestic demand have so far been resilient to higher rates.

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Strategists at FHN Financial expect the Fed to hike interest rates to around 6% by next June. After this week’s hike, the Fed could achieve that without another 0.75 point rate hike.

“The obvious dilemma for financial markets is that many things can be true at the same time, and many of them are going in different directions. The Fed could slow down in December but still hit the 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 — like higher borrowing costs, lower stock prices and a stronger dollar — that dampen demand. Changes in expected interest rates and not just what the Fed does at each meeting, may affect broader financial conditions.

Many investors this year have been keen 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 work to slow the economy.

Any discussion by Mr. Powell about how officials view the potential for a higher rate path could dampen any market exuberance about a slower pace of hikes, economists said. “It’s about the destination now, not the journey,” Michael Gapen, chief US economist at Bank of America, said in a report Monday.

write it Nick Timiraos at nick.timiraos@wsj.com

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