How to read the US Federal Reserve's projections like a pro

Fed officials raised borrowing costs by three-quarters of a percentage point, their third-straight jumbo increase, on Wednesday. PHOTO: REUTERS

NEW YORK - US Federal Reserve officials released both an interest rate decision and a fresh set of economic projections on Wednesday.

Officials raised borrowing costs by three-quarters of a percentage point, their third straight jumbo increase, taking their official interest rate to a range of 3 per cent to 3.25 per cent. But they also pencilled in additional increases for the rest of this year and next, projecting that rates would reach 4.4 per cent by the end of the year and climb to 4.6 per cent by the end of 2023.

Here is how to read the numbers released on Wednesday.

The dot plot, decoded

When the central bank releases its summary of economic projections each quarter, Fed watchers focus obsessively on one part in particular: the so-called dot plot.

The dot plot shows the Fed's 19 policymakers' estimates for interest rates at the end of 2022, along with those for the next several years and over the longer run. The forecasts are represented by dots arranged along a vertical scale.

Economists watch closely how the range of estimates is shifting, because it can give a hint at where policy is heading. Even so, they fixate most intently on the middle dot (currently the 10th). This middle, or median, official is regularly quoted as the clearest estimate of where the central bank sees policy heading.

The Fed is trying to wrestle down the fastest inflation in 40 years, and to do that, officials believe that they need to lift interest rates enough to slow spending, crimp business investment and expansion, and cool off a hot job market. The central bank has been moving rates up quickly, and as inflation has remained stubbornly rapid, expectations for future increases have also climbed.

In June, the median official expected interest rates to close out the year at between 3.25 per cent and 3.5 per cent. This has now changed, with the median official expecting rates to climb to 4.4 per cent by year end and to 4.6 per cent in 2023. After that, rates are expected to begin to come down, so that they are 3.9 per cent by the end of 2024 and 2.9 per cent in 2025.

What the Fed is saying here is that rates are going to go further into economy-restricting territory - and that they will stay there till 2025.

Unemployment projections are key

Much of Wall Street is fixated on a critical question: Will the Fed accept a much higher jobless rate in its bid to counter rapid inflation? Page two of the economic projections holds some preliminary answers.

The Fed has two jobs. It is supposed to achieve maximum employment and stable inflation. Unemployment has been very low, employers are hiring voraciously and wages are shooting higher, so officials think that their full employment goal is more than satisfied. Inflation, on the other hand, is running at more than three times their official target.

Given that, the central bankers are now single-mindedly focused on bringing price gains back under control. But once the job market slows, joblessness begins to rise and wage growth moderates - a series of events that officials think is necessary for getting back to slow and steady price gains - the really difficult phase of the Fed's manoeuvring will begin. Central bankers will have to decide how much joblessness they are willing to tolerate, and may have to judge how to balance two goals that are in conflict.

Fed chair Jerome Powell has already acknowledged that the adjustment process is likely to bring "pain" to businesses and households. The Fed's updated unemployment rate projections show how much he and his colleagues are prepared to tolerate.

Unemployment is being seen as rising to 4.4 per cent in both 2023 and 2024, up from 3.7 per cent currently and higher than what officials previously saw it climbing to.

US growth outlook

The road towards higher unemployment is paved with slower growth. To force the job market to cool and inflation to moderate, Fed officials believe they have to drag economic growth below its potential level - and how much it is expected to drop can send a signal about how punishing the Fed thinks its policies will be.

Many experts think that the economy is capable of a certain level of growth in any given year, based on fundamental characteristics like the age of its population and productivity of its companies. Right now, the Fed estimates the longer-run sustainable level to be about 1.8 per cent, after adjusting for inflation.

Last year, the economy was growing much more strongly than that - it began overheating. Now, to bring inflation down, it needs to slow below that rate for some time, the logic goes. This is why the Fed sees growth dipping to 0.2 per cent this year and staying at 1.2 per cent next in its projections. The economy ran hot, and now officials think it needs to run cold.

Pro tip: Ignore the inflation estimates

The inflation estimates in the Fed's projections typically do not offer a lot of insight.

This is because the Fed's forecasts predict how the economy will shape up if central bankers set what they consider "appropriate" monetary policy. To qualify as appropriate, by definition, monetary policy must push price increases back towards the Fed's 2 per cent annual average goal over the course of a few years. This means Fed inflation forecasts always converge back towards the central bank's goal in economic estimates.

True to form, the new forecasts show headline inflation falling back to 2 per cent by 2025.

If there is a glimmer of utility here, it is how long the central bank sees it taking to wrestle prices back to its target level. Fed officials think that core inflation - the figure that strips out food and fuel costs to get a sense of underlying price patterns - will remain at 2.1 per cent in 2025.

The upshot? It will be a long road back to normal, even in an ideal world. NYTIMES

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