The Federal Reserve is due to release an interest rate decision and a new set of economic forecasts on Wednesday, and as it tries to figure out what the next phase of the central bank’s battle against rapid inflation will look like, Wall The city awaits these estimates.
Officials are expected to raise borrowing costs by three-quarters of a percentage point, making it the third consecutive jumbo-sized increase, with the discount rate ranging from 3% to 3.25%. But investors expect the central bank to likely forecast even higher interest rates by the end of the year, so analyze the Fed’s first set of economic forecasts since June to see what’s next. Here’s how to read the numbers and what to watch out for when it releases Wednesday at 2pm.
Decoded dot plot
When Central Banks Release It Summary of Economic Forecasts Each quarter, Fed watchers focus relentlessly on one particular segment. It’s a so-called dot plot.
The dot plot shows the 19 Federal Reserve policymakers’ estimates of interest rates at the end of 2022, as well as their estimates for the next few years and over the longer term. Forecasts are represented by dots placed along a vertical scale.
Economists are watching closely how the range of forecasts is changing. Still, they’re most focused on the middle dot (now his 10th). This middle or median official is regularly cited as the clearest estimate of where the central bank sees policy direction.
The Fed is trying to contain the fastest inflation in 40 years. To do that, officials believe, it will be necessary to curb spending, curb corporate investment and expansion, and raise interest rates just enough to cool the overheated job market. Central banks are raising interest rates rapidly, and with inflation remaining stubbornly rapid, expectations for future increases are also rising.
In June, median officials expected rates to end the year between 3.25% and 3.5%. This set of projections will almost certainly go up — at this point, investors are betting Interest rates will rise to the 4-4.25% range by the end of the year.
Wall Street is also keeping a close eye on when and where interest rates will peak. In June, half of officials said he expected interest rates to peak at or above his 3.75-4% at the end of 2023. This number, too, is likely to rise further.
The most important trick for reading dot plots? Notice where the numbers are compared to the long-term median forecast. This figure is sometimes referred to as the “natural” rate and was recently 2.5%. This represents the theoretical boundary between accommodative and restrictive monetary policy.
The greater the gap between the Fed’s rate forecasts and estimates of “natural” interest rates, the more likely officials expect inflation to weigh on the economy.
Unemployment projections are key
Most of Wall Street is fixated on this key question: Will the Fed accept much higher unemployment to counter rapid inflation? The second page of economic forecasts may contain some tentative answers.
The Fed has two jobs. It is supposed to achieve maximum employment and stable inflation. With unemployment so low, employers hiring eagerly and wages soaring, officials believe the full employment target has been well met. Meanwhile, inflation is more than three times the official target.
Given that, central banks are now single-mindedly focused on getting inflation back under control. But as the job market slows, unemployment begins to rise and wage growth slows, officials believe it will take a series of events to return to moderate and steady inflation. The central bank will have to decide how much unemployment it can tolerate, and he may have to decide how to balance the two conflicting goals.
Fed Chairman Jerome H. Powell has already admitted that the adjustment process is likely to bring “pain” to businesses and households. The Federal Reserve’s latest unemployment forecast shows how much he and his colleagues are ready to tolerate.
The numbers to watch are the median unemployment rate projections for 2023, 2024 and 2025. This is because the Fed’s policy takes time to be reflected across the economy, so the greatest impact will be felt over time.
The Fed’s latest series of forecasts saw the unemployment rate rise to 4.1% in 2024 (September is the first series of forecasts to include 2025). 3.7% unemployment rate And higher than the 4% unemployment rate the Fed deemed sustainable over the long term.
“These are the unfortunate costs of keeping inflation under control,” Mr. Powell said late last month. “But failure to restore price stability would mean far greater pain.”
See growth outlook
The road to higher unemployment is paved by slowing growth. Fed officials believe that to cool the job market and keep inflation under control, economic growth must fall below potential levels.
Many experts believe that an economy is capable of a certain level of growth in any given year, based on fundamental characteristics such as the age of the population and the productivity of firms. The Fed currently estimates a long-term sustainable level of about 1.8%, adjusted for inflation.
Last year, the economy grew much stronger than that and started to overheat. Now, the logic is that in order for inflation to go down, it needs to slow below that rate for some time. In the latest forecast, officials see him at 1.7% growth for this year and next year. If they show a bigger decline this time, it indicates they think a more aggressive blow to the economy is needed to tackle lower inflation.
Pro Tip: Ignore Inflation Estimates
Inflation projections in the Federal Reserve’s projections don’t usually provide much insight.
This is because the Fed’s projections predict how the economy will shape if central banks set what they consider to be “appropriate” monetary policy. For monetary policy to be considered “right”, by definition, it must push inflation back towards the Fed’s average annual target of 2% over several years. In other words, the Fed’s inflation forecast always converges towards the central bank’s economic forecast target.
If there is a small utility here, it is how long the central bank thinks it will take prices to return to their target levels. In June, for example, officials did not see that happening until 2024, indicating that the road to more subdued inflation is likely to be a long way off.