Fed Watchers Put 'Finger in the Air' and See Rate Peak Above 5%
Federal Reserve Chair Jerome Powell’s declaration that peak interest rates will need to go higher than previously thought has Wall Street making its best guess on that final level.
The Federal Open Market Committee in September estimated reaching a target range of 4.5% to 4.75% in 2023. But Powell, citing high inflation and a very tight labor market, told reporters Wednesday that “incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.”
He spoke after officials raised rates by 75 basis points for the fourth straight time to a 3.75% to 4% range, extending the central bank’s most aggressive tightening campaign since the 1980s.
Four Fed policymakers who spoke since the meeting similarly flagged a higher rate without giving a precise forecast. Richmond Fed President Thomas Barkin said Friday on CNBC that it’s “entirely conceivable” the central bank may need to raise rates above 5%, though that isn’t the current plan.
With little to go on beyond Powell’s remarks and the Fed’s statement on Wednesday, Nomura Holdings Inc. economists after the meeting raised their estimate of where rates will peak to a range of 5.5% to 5.75%. Others reaffirmed projections that were for 5% or higher next year.
Powell said the goal was to be ‘’sufficiently restrictive” to bring inflation back down to the Fed’s 2% goal. One means is to set rates above inflation or expected inflation, though he included several ways in which underlying inflation or inflation expectations could be measured.
“I don’t have a specific number for you” on how to measure inflation, he said.
US core prices, which excluded food and energy, rose 5.1% in the 12 months through September, according to the gauge favored by the Fed.
“Our view about the terminal rate is more finger-in-the-air estimate than high science,” said Jonathan Millar, a senior economist at Barclays Plc in New York.
Millar is estimating 5% to 5.25% as the terminal rate, while pointing out there’s a high level of uncertainty. “The lack of clarity reflects the fact that they don’t have a lot of conviction in any of the standard approaches, which has led them to a more ad hoc approach that is judgmental in nature,” he said.
Powell also discussed the need to cool the US labor market.
October’s employment report, released Friday, showed only slight progress in that direction. Businesses boosted hiring last month by a more-than-expected 261,000 and average hourly earnings accelerated from September, while unemployment rose to 3.7%.
“We are still seeing a tight labor market and wage pressures are still quite elevated,” said Lydia Boussour, senior economist at EY Parthenon, who expects a terminal rate of 4.5% to 4.75%. “The Fed has to keep at it.”
In separate remarks Friday, Boston Fed President Susan Collins said her peak-rate view had risen since September, but “I really do think it is premature to be too specific about what that might actually look like because things are still evolving.”
Minneapolis Fed chief Neel Kashkari told the Associated Press that he expects to issue a higher rate-peak forecast next year than he did in September, while declining to specify that number now. And Chicago Fed President Charles Evans told Reuters he expects the Fed to eventually raise rates “slightly higher” than the September projections.
Economists surveyed by Bloomberg prior to the meeting projected a terminal rate of 5%. Investors are betting the Fed will hike 50 basis points in December and reach a peak of around 5.1% by mid-2023.
What Bloomberg Economics Says...
“Powell sent a clear message to markets at the Nov. 2 FOMC meeting: Don’t expect us to continue raising rates by 75 basis points every time, but we’re not making a dovish pivot either. We expect the Fed to slow the pace of rate increases to 50 bps at the December meeting and release a new dot plot indicating a terminal rate of around 5%.”
-- Anna Wong, Andrew Husby and Eliza Winger (economists)
The FOMC in its “dot plot” projections has revised up its view of the top rate at each of the three quarterly forecasts this year in response to inflation that has continued to top forecasts. There will be two consumer-price reports before the December FOMC decision, including October’s data released on Nov. 10.
Powell used his post-meeting press conference to shift the focus from the size of the next hike, which has been a central focus for Wall Street, to rates peaking at a higher level and staying there for long enough to cool inflation.
“The issue going forward is get rates to a plateau, be relatively confident that it’s restrictive,” said Vincent Reinhart, chief economist at Dreyfus and Mellon, who puts the terminal rate at 5% to 5.25%. “So keep the funds rate firm for as long as it takes until you’re convinced inflation’s on the way down back to goal.”
One standard way of assessing positive real rates desired by Powell would be rates in excess of expected inflation over the coming year, which would be 5% using the year-ahead estimate in the University of Michigan survey, or around 3.5% for 2023 core inflation, excluding food and energy, as measured by professional economists’ forecasts.
“So that would say that the real funds rate is around zero or even still negative,” said Jonathan Wright, an economics professor at Johns Hopkins University. “And that would mean it has a long way to go to achieve the restrictive stance that is needed.”
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