The Federal Open Market Committee’s announcement of a 75-basis-point (bp) rate hike on June 15 revealed a shift in the Fed’s thinking. Fed communication through May and much of June had largely signaled it would hike rates by 50 bps at its June meeting. Why the change? In my view, the Fed realized that it is "behind the curve” and is trying to catch up to inflation.
Up, up and away
A series of reports in the days leading up to the FOMC meeting revealed that economic indicators were still heating up. Crucially, I believe a severe CPI gain and consumer surveys that reported rising consumer expectations of inflation persuaded the Fed to shift gears and take a more aggressive approach to inflation control.
Clues about the Fed’s thinking
The Summary of Economic Projections and the “dot plot” offered additional insight into the Fed’s thinking.
GDP growth: The FOMC slashed its median projection for 2022 and 2023 GDP growth (Q4/Q4 basis) to 1.7%, slightly lower than its long-term growth projection of 1.8%. This trajectory signals the FOMC’s expectations of a “soft landing.” Consistent with the soft landing outlook, the FOMC projected rising unemployment rates through 2024. Sorry to say, we believe the FOMC is likely to need to cut its growth projections again.
Inflation: Consistent with the surge in food and energy prices, the FOMC significantly increased projections of inflation (measured Q4/Q4 percent change in PCE price index) for 2022. It trimmed projected inflation for 2023 and 2024, which we believe suggests the FOMC thinks the surge will decline after this year. Even so, projected inflation for 2022, 2023 and 2024 exceeds the Fed’s 2.0% inflation target.
The federal funds rate: The “dot plot” revealed big adjustments in the median forecasts for the federal funds rate, particularly at the end of 2022.
Channeling Alan Greenspan
If Fed Chair Jay Powell used to resemble Arthur Burns, a previous Fed Chair who allowed inflation to spiral out of control, he may now be channeling Alan Greenspan, who tightened aggressively in 1988-1989 and in 1994-1995 to reduce inflation. In our view, it appears the FOMC is planning to go well over the neutral rate in 2023 to bring inflation down. The door is likely open for another 75-bp hike in July.
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