- The Federal Reserve kept interest rates steady, but also said it still expects to raise rates through the end of the year and that rate cuts next year will be smaller than previously expected.
- Along with the interest rate forecast, the Federal Reserve System has also significantly raised the economic growth forecast for this year. This year, the gross domestic product is currently forecast to grow by 2.1%.
- In addition to keeping interest rates relatively high, the Fed has continued to reduce its bond holdings, which has reduced the central bank’s balance sheet by about $815 billion since June 2022.
The Federal Reserve left interest rates unchanged in its decision published on Wednesday. It also said it still expects rates to rise again by the end of the year and that rate cuts next year will be smaller than previously expected. A possible rate hike, if it materializes, will happen in this cycle, according to forecasts released at the end of the central bank’s two-day meeting. If the Fed makes the move, it will lead to dozens of rate hikes since March 2022, when it began tightening policy. Markets have fully appreciated the indifference of this meeting, which has kept the federal funds rate in a target range of 5.25%-5.5%, the highest level in about 22 years. The exchange rate determines what banks charge for day-to-day loans and also spreads across many types of consumer debt.
While no rate hikes are expected, there is still a lot of uncertainty about where the Federal Open Market Committee will go in setting rates. Based on the documents released on Wednesday, the preference seems to be for tighter policy and higher interest rates in the long term. The outlook weighed on markets, with the S&P 500 down nearly 1% and the Nasdaq down 1.5%. Stock markets fluctuated as Federal Reserve Chairman Powell answered questions at a news conference. “We can carefully determine the extent of future policy tightening,” Powell said.
However, he added that the central bank would like to see more progress in the fight against inflation. “We’d like to see strong evidence that we’ve actually reached the appropriate level and that we’re seeing progress, and we welcome that. But you know, before we want to draw those conclusions, we need to look for more progress,” he said. Projections published in the Fed’s chart show another rate hike this year, followed by two rate cuts in 2024, two fewer than when the figure was last updated in June. This would make the fund rate around 5.1%. The chart allows participants to anonymously indicate where they think interest rates are headed.
Twelve members of the meeting supported further rate hikes, while seven were against. It generated more opposition than the meeting in June. It was recently confirmed that Fed Governor Adriana Kugler did not vote at the last meeting. Forecasts for the federal funds rate in 2025 were also revised upward, with an average forecast of 3.9%, up from 3.4% previously.
In the longer term, FOMC members expect the funds rate to reach 2.9% in 2026. This is above the interest rate that the Fed considers a “neutral” interest rate that neither stimulates nor constrains economic growth. This is the first time the committee is looking forward to 2026. In the long term, the expected neutral interest rate remains at the level of 2.5 percent.
“Chairman Powell and the Fed sent a decidedly hawkish, long-term bullish message at today’s FOMC meeting,” wrote Citigroup economist Andrew Hollenhorst. “The Fed expects inflation to cool steadily while the labor market remains historically tight. However, we think persistent labor market imbalances are likely to keep inflation ‘stuck’ above target.”
Higher Economic Growth.
Along with the interest rate forecasts, the members have also significantly raised the economic growth forecasts for this year, now predicting an increase of the gross domestic product by 2.1% this year. This is more than twice as much as in June and shows that member states are not expecting a recession in the short term. The GDP forecast for 2024 was revised to 1.5% from 1.1%.
Federal funds target rate since 2006
Expected inflation, as measured by the core consumer price index, also fell to 3.7%, down 0.2 percentage points from June; the unemployment outlook was also lowered to 3.8% from the previous 4.1%.
Some changes in the post-meeting statement reflected adjustments to the economic outlook. The committee described economic activity as “firmly expanding” compared to “moderate” in its previous statement. The report also noted that employment growth “has slowed in recent months but remains strong.” This is in stark contrast to previous language that characterized the employment situation as “strong.
In addition to keeping interest rates relatively high, the Fed has continued to reduce its bond holdings, which has reduced the central bank’s balance sheet by about $815 billion since June 2022. The Fed is allowing up to $95 billion a month in proceeds from maturing bonds rather than reinvesting them.
Shift to a more balanced perspective.
The Fed’s action comes at a delicate time for the US economy. In recent public appearances, Fed officials have signaled a shift in thinking from a belief that it is better to do too much to reduce inflation to a new, more balanced view. That’s partly because the impact of interest rate hikes, the Fed’s tightest monetary policy since the early 1980s, is seen as lagged. There are growing signs that central banks could achieve a soft landing that reduces inflation without sending the economy into a deep recession.
However, the future remains far from clear, and Fed officials have expressed caution about declaring victory too soon. “We, like many, expected Powell to give a nod to Jackson Hole,” said Alexandra Wilson-Elizondo, deputy director of multi-asset strategy at Goldman Sachs Asset Management. “But the graduation was crazier than expected. While previous policy tightening is still ongoing, the Fed can pause by going into standby mode. The biggest risk, however, is continued damage to its biggest asset – its anti-inflationary credibility, which would require support for a hawkish response function.
She said the median increase next year could be driven by recent increases in energy prices and the elasticity of consumption. “We don’t see any bearish catalysts on the horizon, although strikes, shutdowns and student loan repayments will affect data volatility between now and the next decision. So we think their next meeting will be live. one, but no deal,” said Wilson-Elizondo. Employment is stable with the unemployment rate at 3.8%, only slightly higher than a year ago. The number of jobs fell, helping the Fed make progress on a supply-demand mismatch that once left two jobs for every unemployed person. Inflation data also improved, although annual interest rates remain well above the Fed’s 2% target. The central bank’s preferred reading for July showed core inflation at 4.2%, which excludes volatile food and energy prices. Consumers account for about two-thirds of all economic activity, and their spending remains strong even as savings decline and credit card debt tops $1 trillion for the first time. A recent University of Michigan study showed that one- and five-year inflation expectations are at multi-year lows.