The Fed Isn’t Getting the Economy It Expected
Federal Reserve policy makers’ projections for inflation this year look as if they could be too high, while their GDP projections look too low.
When the Federal Reserve’s rate-setting committee sits down Tuesday and Wednesday, one thing it has to grapple with is that underlying inflation is looking cooler than it thought just a few months ago. Another: The economy is looking much stronger.
The central bank’s policy makers will need to update the economic projections to reflect these changes. But an environment with a bit less inflation and more growth has interest-rate implications, too. While policy makers are almost certain to keep rates on hold, and might be comfortable leaving them on hold for the remainder of the year, rate cuts are likely to be even further from their minds now.
The last time the Fed released projections, at their June meeting, they showed that policy makers on balance thought that their preferred measure of consumer prices, from the Commerce Department, would be 3.2% higher in the fourth quarter this year from a year earlier. They forecast that core prices, which exclude food and energy items to better capture inflation’s underlying trend, would be up 3.9%.
That headline inflation forecast might end up being in the ballpark, but mostly because of the run-up in fuel prices after Saudi Arabia and Russia extended crude-oil production cuts. For core inflation to hit the Fed’s projection, Morgan Stanley economists’ estimates indicate it would need to increase at a 4.5% annual rate in the final four months of this year, after rising at a 2.6% rate over the prior four months. Morgan Stanley economists’ own forecast calls for core prices to be up 3.3% in the fourth quarter from a year earlier. Other forecasts are also now below the Fed’s, with both Goldman Sachs and JPMorgan Chase penciling in a 3.4% gain in core prices, for example.
This is good news for the Fed and is a big part of why a rate increase at this week’s meeting seems so unlikely. The Fed’s updated projections will probably still show one last, quarter-percentage-point hike to the central bank’s target range on interest rates by the end of the year, but this might best be regarded as policy makers’ retaining their option to hike. Absent a reacceleration in core inflation, the Fed’s tightening cycle might be over.
Then again, considering how much stronger the economy has been than they thought, policy makers might also forecast fewer rate cuts next year than they previously saw.
The Fed’s June projections showed a median forecast that gross domestic product would grow just 1% in inflation-adjusted terms in the fourth quarter from a year earlier. But economists polled by S&P Global Market Intelligence last week estimate that GDP will be up by 1.8% in the fourth quarter—a forecast that has embedded in it an expectation that the economy will hit a rough patch at the end of the year, as factors such high gasoline prices, the United Auto Workers’ strike and the resumption of student-loan payments weigh on the economy.
The resilience of GDP growth might lead the policy makers to conclude that the economy is handling all their rate increases better than they had expected. In June, they had projected that their target range on rates at the end of next year would be three-quarters of a percentage point lower than the current 5.25% to 5.5%. This week’s projections might show a decline of perhaps a half point instead.
For investors, this all amounts to a mixed bag: Any hints that the Fed’s rate increases might have come to an end would be welcome, but a lesser disposition to cut could leave long-term Treasury yields, and other long-term rates such as on mortgages, uncomfortably high. For most Americans, less inflation and a resilient economy count as good things. Here is hoping they can last.
Write to Justin Lahart at Justin.Lahart@wsj.com
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Business NewsEconomyThe Fed Isn’t Getting the Economy It Expected
First Published:18 Sep 2023, 10:49 PM IST
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