Insights from the Fed

by
Leo Wealth

Christos Charalambous, CFA

The Federal Reserve’s eagerly anticipated September interest rate decision and summary economic projections are finally out. The Fed stayed on course with its hawkish message to combat inflation and delivered a 0.75% interest rate increase (to 3.25%) which was in line with market expectations.

The Sept SEP (summary of economic projections) indicated a material downward revision for 2022 GDP growth and, to a lesser extent, for 2023 GDP growth as well. In line with the Fed’s rhetoric for some pain in the labor market, the Fed also indicated a rise in the U.S. unemployment rate in 2023 to 4.4%. From a historical perspective, this matters as even a 0.5% increase in the unemployment rate is sufficient to trigger a mild recession. On the other hand, the Fed does not project a further increase in the unemployment rate in 2024, which could be perceived as a positive sign as the Fed’s aim is really to bring down inflation without compromising the economy or the labor market too much, i.e., the Fed aims for a ‘soft landing.’ 

On the inflation front, the Fed is seeing somewhat stickier inflation for 2022 as it revised its projection higher (vs. June). On a more positive note, the Fed also introduced a 2025 outlook for inflation, which points to its long-run estimate of 2.0%. Regarding the median interest rate projection by the Fed members, the Fed revised its 2022 and 2023 rate estimates higher, with the 2023 median projection, in particular, coming in at the upper end of consensus expectations, i.e.,> 4.5%. Even though in the near term, the Fed is likely to be seen to keep rates ‘higher for longer’, the Fed is also projecting interest rate cuts in 2024 and 2025 as the inflation outlook normalizes. Long-run inflation expectations are an important variable for markets, and today’s SEP projections point to a well-anchored long-run inflation outlook and restored credibility for the Fed as it aims to fulfill its mandate of full employment and price stability.

A cynic may point to the Fed’s lackluster record of economic projections, but it’s not out of the question that a ‘soft landing’ scenario could actually be achieved. As such nominal Treasury yields, interest rate projections, and the U.S. dollar could collectively be approaching a peak soon. Lastly, one could also argue the Fed’s and the bond market’s hawkish pendulum is approaching certain limits when the Fed itself is projecting near-zero GDP growth. In other words, it will be very challenging for the Fed to tighten even more as projecting recessionary GDP estimates will likely be seen as a red line by the market. 


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