Fed to downshift to half-point hike but point to higher peak

The tricky part for Chair Jerome Powell will be convincing investors that this isn’t a dovish pivot. PHOTO: REUTERS

NEW YORK – The US Federal Reserve is poised to moderate its aggressive tightening on Wednesday while signalling that interest rates will ultimately go higher than previously forecast.

The tricky part for chair Jerome Powell will be convincing investors that this is not a dovish pivot and that officials will not prematurely end their assault against inflation that is running three times higher than their 2 per cent goal. 

The Federal Open Market Committee (FOMC) is widely expected to raise rates by 50 basis points and bring its benchmark target rate to a range of 4.25 per cent to 4.5 per cent, the highest since 2007. Fresh quarterly economic projections released after the meeting will also shed light on how much further policymakers expect rates to go. 

Economists surveyed by Bloomberg see that median estimate peaking at 4.9 per cent after Mr Powell said they will need to lift rates higher than previously anticipated. That implies the FOMC stepping down to 25 basis-point moves in February and March and then putting policy on pause. Investors see things the same way, according to current pricing in interest rate futures markets.

The decision, as well as the forecasts, will be announced at 2pm in Washington. Mr Powell will hold a press conference 30 minutes later.

Consumer price data released on Tuesday suggest the worst of US inflation may have passed, making it easier for officials to downshift to a smaller rate increase this week. But Mr Powell could use his press conference to remind the public that officials are not going to let up until inflation is clearly on a path back down to 2 per cent.

“All eyes will be on the dot plot and the conference and what fed chair Powell will be telling us in terms of the path for interest rates going forward,” said Ms Lydia Boussour, senior economist for EY Parthenon, referring to the quarterly projections for rates displayed as a chart of anonymous dots though 2025 and in the longer run.

At their September meeting, Fed officials saw rates reaching 4.6 per cent by the end of next year. But policymakers say those expectations have since moved up following economic data showing that while inflation is easing, it remains stubbornly high. 

Officials also say the labour market is still out of balance, with demand for workers exceeding labour supply and wage growth not letting up.  

The projections will offer insight on policymakers’ latest views for where they expect rates to go.

But the Fed chief is unlikely to commit to a specific path, preferring to keep his options open, said Mr Michael Pugliese, an economist at Wells Fargo & Co. 

“I think they’ll preserve flexibility,” he said.  

The rate projections could offer clues on how soon officials expect to pause the rate increases.

For example, a more modest increase in the terminal rate may suggest that officials could stop hiking rates as soon as March, while a higher peak may suggest that rate increases could continue further into 2023, said SGH Macro Advisors chief US economist Tim Duy.

But he said it will also be important to hear from Mr Powell about how officials will know that it is time to pause the rate increases or if they should keep hiking. 

“They’ve been edging closer to something that they think is a terminal rate, and that appears to be something near 5 per cent,” said Professor Duy. “What conditions would sort of reinforce that?” 

One key phrase to watch for in the FOMC statement is whether officials continue to say that “ongoing increases in the target range will be appropriate” to bring rates to a level that is sufficiently restrictive to reduce inflation. 

Removing the word “ongoing” could send a dovish signal and suggest that the Fed is likely to pause rate increases in March, sooner than expected, according to Dr Roberto Perli and Dr Benson Durham of Piper Sandler & Co.  

However, Mr Derek Tang, an economist with LH Meyer, said Fed officials could also decide to keep the “ongoing increases” wording in the statement for the remainder of the hiking cycle to avoid sending a signal that could ease financial conditions.

“There’s little cost to them to keep ‘ongoing increases’ in there until the first meeting with no hike,” Mr Tang wrote in an e-mail note.

The projections will also reveal what officials expect to see from the US economy in terms of growth, the unemployment rate and inflation.

Forecasts showing that officials now expect it to take longer for inflation to come down to their target could help to justify their higher interest-rate projections, said ING chief international economist James Knightley.  

EY Parthenon’s Ms Boussour said policymakers could downgrade their outlook for 2023, projecting lower economic growth that is closer to zero and a higher unemployment rate that is approaching 5 per cent, up from the current rate of 3.7 per cent. 

“I think there will be that idea coming out of the new projections that the Fed is ready to tolerate some more economic pain in order to restore price stability,” she said.

Wells Fargo & Co’s Mr Pugliese said even if officials present a base case that avoids a recession, the direction of where those indicators are headed can offer insight on how officials view recession risks.

ING’s Mr Knightley said Mr Powell could use the press conference to tell the public that officials believe there is still a path, albeit a narrower one, to achieving a soft landing, where they succeed in bringing inflation down while minimising the pain for households.

“I think the Fed will be saying, ‘well recession is a possibility, but it’s not our base case,’ ” he said. BLOOMBERG

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