At its September meeting, the Federal Reserve delivered a 0.75 percentage point increase to its benchmark overnight lending rate, the federal funds rate, in a move that most investors had expected. The hike is the third consecutive such move since June as the Fed desperately tries to put a lid on soaring inflation. Following another jumbo rate hike, how will the hawkish Fed move next?
The Fed further outlines its blueprint
At the conclusion of each Fed meeting, the Fed doesn't only announce whether or not it's going to raise rates, but Fed Chairman Jerome Powell also speaks about the Fed's outlook on the economy.
After its September meeting, Powell's tone and comments seemed to get darker than they have in the past, as he acknowledged that the intense rate hikes from the Fed are likely to have consequences.
"The chances of a soft landing are likely to diminish to the extent that policy has to be more restrictive," Powell said at the press conference. Powell added, "No one knows whether this process will lead to a recession or, if so, how significant that recession would be."
In addition, the Fed updates its projections for the federal funds rate on what is called the dot plot, which shows the Fed's median projections for its benchmark lending rate. The Fed expects to hike the federal funds rate, which is currently inside a range of 3% and 3.25%, to 4.4% by the end of the year. With only two Fed meetings left in November or December, that implies the Fed intends to do another three-quarter percentage point rate hike and then a half-point hike to end the year.
The median forecast also has the Fed raising the federal funds rate to 4.6% in 2023, which means the Fed expects to be mostly done with its war on inflation by the end of the year. It can take six months or so for rate hikes to work their way through the economy, so the full impact of all of these rate hikes really won't be felt until 2023. Furthermore, several Fed members expect the Fed to have to jack up rates to a range of 4.75% to 5% in 2023.
Will the Fed's plans play out?
It's tough to say right now whether the Fed's blueprint for rate hikes will play out. I do think we will start to see more meaningful progress on inflation toward the very end of the year and in early 2023 because these rate hikes still need time to fully impact the economy.
Shelter inflation on things like rent could be a festering problem and one reason inflation lingers longer than some think. But on the other hand, the Fed's hikes may go too far and push the economy into a more severe recession. If that happens and demand drops, the Fed may need to pivot and stop raising rates or actually drop them.
Then, of course, there is the unknown impact of quantitative tightening. The Fed has begun to unwind its massive balance sheet, which will effectively pull liquidity out of the economy. There were issues when the Fed tried to do this prior to the pandemic, and it's hard to know what the impact of quantitative tightening will be on real interest rates.
Ultimately, I feel like the Fed could certainly change its outlook. If inflation data starts to show improvement in October and November, then the Fed may not press ahead with another 0.75 percentage point rate hike. The Fed is hawkish for now, but it could change on a dime in these turbulent times.