The Federal Reserve hiked interest rates by 75 basis points on Wednesday, announcing there was much more to come. The quarterly forecasts of the policymakers show that the key interest rate will even reach 4.6% next year. The Dow Jones Industrial Average remained volatile, bouncing down, then up, and then back down after the Fed policy statement.
The Fed’s third straight hike of 75 basis points raised its benchmark interest rate, the interbank rate, to a range of 3% to 3.25%.
US Federal Reserve rate hike outlook
Federal Reserve policymakers now expect the Federal Reserve’s interest rate to rise to 4.4% by the end of 2022, according to new quarterly forecasts to be released along with the policy statement. This implies a total of 5 more quarter point rate hikes in the November and December meetings.
However, this forecast represents the median forecast from all 19 Fed policymakers. Fed Chair Jerome Powell noted that there is not broad consensus as a number of policymakers see the likelihood of a slightly smaller 1 percentage point increase by the end of the year. So stay tuned.
Fed projections show that interest rates will peak at 4.6% in 2023, with 12 out of 19 policymakers forecasting rates at least that high.
Forecasts show that the Fed’s interest rate will fall to 3.9% by the end of 2024.
The forecasts up to 2023 are broadly in line with financial market expectations, but are somewhat more restrictive. Ahead of the Fed’s policy statement, markets have priced in a 62% chance the Fed will hike to 4.25% to 4.5% by the end of the year, according to CME Group’s FedWatch page.
Markets see an above-average chance that the Fed will hike again to a 4.5%-4.75% range in 2023, with the target range falling to 4%-4.25 by year-end.
The Fed has also introduced an interest rate forecast for 2025. While the key interest rate is expected to drop to 2.9%, this is still somewhat hawkish territory.
Fed projections imply that rate cuts will come on the table once the Fed’s favorite core inflation measure falls to around 3%. Powell also said that the federal funds rate would become positive in real terms, ie higher than the inflation rate.
Fed Chair Powell talks about US recession
“Nobody knows if this process will lead to a recession,” Powell said at his post-meeting news conference. However, he added that “the chances of a soft landing will be reduced” if policies have to be kept tighter for an extended period of time.
He also spoke of a “difficult correction” needed to bring the housing market back into balance.
However, Powell said, “The historical record warns against premature policy easing.”
In other words, the Fed is guided by the experience of the 1970s, when policymakers repeatedly cut rates as unemployment rose, only to see inflation flare up again. Even if the unemployment rate rises and the economy faces a recession, the Fed won’t cut until inflation pulls back to 2% in a convincing manner.
This echoes the message of Powell’s Jackson Hole speech that shook up the Dow Jones.
The new forecasts show GDP growth decelerating much more sharply, to 0.2% this year and 1.2% next. Fed officials now expect the unemployment rate to rise to 4.4% in 2023 and stay there through 2024. In comparison, the unemployment rate was 3.7% in August and 3.5% in July. Every time the unemployment rate has increased by more than half a percentage point, the US economy has slipped into recession.
Jackson Hole Redux
Powell’s Aug. 26 speech ushered in a reassessment of the Fed’s monetary policy outlook, reversing the dovish impression he made at his July 27 press conference that had helped the Dow Jones cut its losses by more than half and to increase by 14% in summer.
“My main message hasn’t changed at all since Jackson Hole,” Powell said. That was a signal to the financial markets not to see the glass as half full.
August’s hot CPI read provided another major shock. While the headline inflation rate fell to 8.3%, prices for core services like rent, health care and transportation rose 0.6% month-on-month and 6.1% year-on-year, the fastest pace since February 1991. The message: Far -A labor market that is too strong is still keeping inflation far too high.
Dow Jones, Treasury Yield Reaction
After the Fed meeting ended, the Dow Jones reversed modest gains and then rallied as Powell spoke. But the Fed’s hawkish message got through as Powell left the stage. In late afternoon trading, the Dow Jones fell 1.7%. The S&P 500 was also down 1.7%, while the Nasdaq fell 1.8%.
During Tuesday’s session, the Dow Jones Industrial Average is down 16.6% from its peak, down just 2.7% from June’s 52-week closing low. The S&P 500 was 19.6% below its all-time closing high of Jan. 3, but still 5.2% above its closing low of June 16. The Nasdaq Composite is down 29.85% from its record closing high but remains 7.3% below its June low.
Be sure to read the IBD column, The Big Picture, after each trading day for the latest on the prevailing stock market trend and what it means for your trading decisions.
The 10-year Treasury yield, which closed at an 11-year high of 3.57% on Tuesday, fell to 3.51% after the Fed meeting. But the 2-year Treasury yield, which hit 4% for the first time since 2007 on Wednesday, rose 7 basis points to 4.03%.
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