Fed forecasts for the economy predict it will be flat to moribund.
The Federal Reserve (Fed) announced on September 21 that it had hiked interest rates by 75 basis points (bps), or three-quarters of a percentage point.
The decision came a day after the Federal Reserve Bank of Atlanta cut its closely watched estimate of GDP for the third quarter of 2022 (“GDP Now”) on Sept. 20 to just 0.3 percent after fixed investment in residential real estate fell by -1 .28 percent disappointed when the Atlanta Fed expected it to print at +0.3 percent. (Here, hover over each bar to see how the “GDP Now” elements work together.)
The 75 basis point rate hike was largely priced into the market and expected by most observers. Some were expecting – and fearing – a hike of 100 basis points, or 1 percent. Still, the market reacted negatively to the rate hike, and the Dow Jones Industrials Average fell 1.7 percent. The benchmark S&P 500 fell by the same percentage.
What seemed to worry the market were the disappointing so-called “dot plots,” officially the “Summary of Economic Forecasts,” also released on September 21, prepared by members of the Federal Open Market Committee, the Fed’s policy-arm and its staffs .
The dot charts are basically forecasts of the future direction of the economy at the end of the year for the current year and three years ahead, as well as for the longer term, analyzing gross domestic product (GDP), unemployment, inflation and interest rates.
None of the forecasts are good. As can be seen in the rightmost columns, GDP has ranged from minus 0.3 percent in 2023 to 2.6 percent in 2024. The so-called “central trend” that most estimates tend toward (the top three and the three lowest are). kicked out) – and the best guess, in my opinion – showed GDP growth of no more than 2 percent.
I can’t help feeling that even the central trending area of the estimates is bullish. I suspect inflation will have a longer tail than the 2023/2024 declines that the central trend would indicate. My guess is that a federal funds rate, the rate the Fed charges member banks, needs to be in the 5 to 6 percent range to bring inflation down, especially if employment strength (which we attribute mostly to low labor force participation installment) continues. (The 5-6 percent we think is necessary is the rate to keep inflation stable at the Fed’s preferred 2 percent rate; this is what Fed watchers call the “final rate.”)
The other aspect of lowering inflation is reducing the Fed’s balance sheet. While the Fed increased the burn-off of Fed assets to $95 billion this month, we have long felt that that amount is insufficient. The assets – consisting of government bonds and mortgage-backed securities (MBS) – can be sold instead of “burned off”. Fed Chair Jerome Powell didn’t rule out the possibility, at least for MBS, but not at this point, he said. The MBS sell-off would reduce the cash supply in the economy, creating some liquidity risk but also reducing inflation.
One aspect of continued rate hikes will be that the US dollar will continue to dominate FX markets. For multinationals, this results in lower overseas earnings as earnings are converted. As we wrote earlier this week, companies like Federal Express will suffer these types of translation losses as well as margin pressures.
We are revising our GDP estimate for this quarter to -0.5 percent.
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