The Federal Reserve once again voted unanimously to raise rates by three-quarters of a percentage point - 75 basis points (bps) - today, bringing the target for the federal funds rate to 3.00 – 3.25%, and signaled expectations for continued hikes ahead. Today’s statement was also accompanied by updated forecasts from the Fed (the infamous dot plots), which show a more aggressive path of rate hikes through 2023.
The forecasts, however, were a very different story, with changes across the board. From an economic perspective, the Fed now sees growth slower, unemployment rising faster, and inflation running slightly higher through the remainder of 2022 and throughout 2023. This forces the Fed to make a choice, do they focus on supporting the weakening economic outlook, or prioritize the fight against inflation that stands at levels last seen nearly 40 years ago?
Today’s dot plots show a notable shift higher in the expected path of rate hikes moving forward, with the Federal Funds Rate now forecast to end 2022 around 4.4%, a full percent above the June forecast of 3.4%. That suggests another 75-basis point hike is the most likely scenario at their next meeting in November, followed by a 50-point hike in December. And the Fed expects a single 25-point hike in 2023 – likely to start the year – before starting to ease policy in 2024.
While we much prefer Chair Powell to channel Paul Volcker rather than Arthur Burns, we have our reservations on the Fed’s dealings. Our biggest concern over today’s Fed activities has nothing to do with what they published or said, but rather what they continue to ignore. The M2 money supply is and has been the biggest factor on inflation, yet Powell and the committee statement didn’t mention it once, nor did any reporter ask a question on the topic. While Powell was questioned on the topic at a recent conference by the Cato Institute, he brushed the idea off and continued to push the same tired model of inflation drivers that have left the Fed well behind the curve and constantly revising forecasts higher.
The bottom line is that it’s good the Fed has prioritized the fight against inflation, but it remains overly optimistic in how quickly it will get inflation back under control, especially as the tools they have to tame inflation are like using a drill to hammer a nail. Follow the growth of M2 – which has thankfully slowed and must remain low for the foreseeable future – for guidance on the path forward from here.