While the Fed kept rates unchanged at today’s meeting, between the press conference and forecast updates, Powell and Co. gave plenty of ammo to keep the financial press busy speculating about what may come at the next FOMC meeting this Fall.
Today’s Fed statement itself was a non-event, with minor wording changes noting that the economy is growing at a “solid” rather than “moderate” rate, and employment gains have “slowed” but “remain strong”. It’s in the updated economic projections (the “dot plots”) – which give a peek at how the Fed expects the economic and rate landscape to evolve moving forward – that things got interesting.
The Fed upped its economic growth forecasts for this year and next to 2.1% and 1.5%, respectively, compared to June estimates of 1.0% and 1.1%. Along with stronger growth, the Fed projects a more modest rise in the unemployment rate to 3.8% (prior forecast of 4.1%) and slightly higher inflation of 3.3% (prior forecast of 3.2%). Interestingly, they lowered their forecasts for “core” inflation – which strips out the volatile food and energy components – to 3.7% for year-end 2023, and they have core inflation sitting at 2.6% by the end of 2024. We would take the over on that bet.
What do these outlook changes mean for the path of rates? One more rate hike is anticipated by the majority of policymakers before the end of the year, just as they forecasted in June, but they now believe that rates will then need to remain higher for longer. June projections showed a total of one hundred basis points (bps) of rate cuts anticipated by FOMC members in 2024, but that has now been revised to expected cuts of 50 bps. On balance the dot plots showed a more hawkish outlook.
During the press conference, questions revolved around how the Fed will determine if/when rates have become sufficiently restrictive and no further hikes are expected. Powell here channeled former Supreme Court Justice Potter Stewart’s classic line that he will “know it when he sees it.” In other words, the Fed does not have a high degree of confidence on when exactly the rate hike/cut process will be accomplished. They – by their own admission – have had a very difficult time forecasting how inflation and rates would unfold, and their models still aren’t up to the task.
What makes this so frustrating is that the Fed – and the financial media who have the opportunity to ask questions during the Q&A session – refuse to even discuss the impacts of the money supply on the inflation ills of the past few years. If the Federal Reserve were paying close attention to the money supply, it would know that monetary policy is already tight. While M2 has risen modestly since April following nine-consecutive months of decline, the money supply has contracted 3.7% in the past year. Meanwhile, bank credit at commercial banks as well as their commercial and industrial loans are both down. If this isn’t tight, we’re not sure what tight means.
It remains to be seen how quickly the reductions in the money supply will translate into inflation getting back to the Fed’s 2.0% target, but the Fed has gained some traction against the inflation problem. Given time, the mission can be accomplished, but the Fed must remain patient. They waited far too long to start rate hikes; they shouldn’t jump the gun on cuts.
For now, each FOMC meeting should be considered “active,” meaning the Fed is ready to raise rates further if the data suggests more work to be done. But without a clear path forward the looming government shutdown, resumption of student loan payments, slowing employment growth, and higher oil prices could cloud the Fed’s vision as 2023 comes to a close. Where’s the finish line? Nobody knows for sure, but we aren’t there yet.
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 9/20/2023
