When the Federal Reserve convenes its rate-setting committee on Tuesday and Wednesday, a key consideration will be the unexpected cooling of underlying inflation in recent months. Additionally, the economy is exhibiting significant strength.
The central bank’s policymakers will need to revise the economic projections to account for these changes. However, a more subdued inflationary environment coupled with increased growth also carries implications for interest rates. While it is highly likely that the policymakers will maintain current rates and may feel comfortable doing so for the rest of the year, any thoughts of rate cuts are now even further from their considerations.
The Federal Reserve last shared their projections during their June meeting. They indicated that, on the whole, policymakers expected consumer prices, as measured by the Commerce Department, to rise by 3.2% in the fourth quarter compared to the previous year. Additionally, they projected that core prices, which exclude food and energy items and provide a better gauge of inflation’s underlying trend, would experience a 3.9% increase.
The headline inflation forecast may end up in the ballpark primarily due to the increase in fuel prices following crude-oil production cuts by Saudi Arabia and Russia. According to Morgan Stanley economists, for core inflation to align with the Fed’s projection, it would need to rise at a 4.5% annual rate in the last four months of this year, following a 2.6% increase over the previous four months. In contrast, Morgan Stanley economists predict a 3.3% uptick in core prices during the fourth quarter compared to the previous year. Similarly, other forecasts from Goldman Sachs and JPMorgan Chase suggest a 3.4% gain in core prices.
This news brings positive implications for the Federal Reserve, making a rate increase at this week’s meeting highly unlikely. The Fed’s updated projections may still indicate a final, quarter-percentage-point hike to align with the central bank’s target range on interest rates by year-end. However, it is crucial to consider that policymakers are currently keeping their options open regarding such a move. Unless there is a significant resurgence in core inflation, the Fed’s tightening cycle could potentially come to an end.
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 Federal Reserve’s June projections indicated that the gross domestic product (GDP) is expected to grow by only 1% in real terms in the fourth quarter compared to the previous year. However, economists surveyed by S&P Global Market Intelligence last week estimate a higher growth rate of 1.8% for the same period. This forecast acknowledges potential challenges towards the end of the year, including factors such as increased gasoline prices, the ongoing United Auto Workers’ strike, and the resumption of student loan payments which may impact the economy.
The Federal Reserve’s June projections revealed a median forecast indicating that the gross domestic product (GDP) would only experience a 1% growth in inflation-adjusted terms during the fourth quarter compared to the previous year. However, economists surveyed by S&P Global Market Intelligence last week estimated that the GDP would actually rise by 1.8% in the fourth quarter. This forecast takes into account an expected economic slowdown at year-end due to factors like high gasoline prices, the United Auto Workers’ strike, and resuming student-loan payments placing additional pressure on the economy.
The policy makers may draw the conclusion that the resilience of GDP growth indicates a successful response to their implemented rate increases, surpassing their initial expectations. In June, they had estimated that by the end of next year, the target range for rates would be around 0.75% lower than the current 5.25% to 5.5%. However, this week’s projections might reveal a decline of approximately half a percentage point instead.
For investors, the current situation presents a mixed bag. On one hand, any indications that the Fed’s rate increases may have reached their peak would be warmly received. However, a reduced inclination to make cuts could result in higher long-term Treasury yields and other rates like those on mortgages, which might prove uncomfortably high. As for most Americans, they welcome the prospect of lower inflation and an economy that remains resilient. Let us hope these positive conditions endure.