Fed sticks to its task

In line with market expectations, the Federal Reserve today imposed its third straight 75 basis point increase in the funds target range, which now stands at 3.0 - 3.25 percent. The press release signals there are more rate hikes to come, and also commits the Fed to continuing its policy of quantitative tightening. 

As was the case after the last rate hike, the press release's discussion of the economic background to its decision is skimpy. It almost seems that the Fed is saying to markets, "if you don't understand what we're doing by now, you are never going to understand".  Apart from a short paragraph on the impact of Russia's depredations in Ukraine, this is the entire text on the economy:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Nothing very controversial there. What is striking is that the release offers no hints that the Fed yet sees any indications that its tightening policies are having the desired effect on either the real economy or inflation. Nor is there any mention of inflation expectations, even though keeping these in check is surely the main goal of this series of sharp rate hikes -- after all, there is not much that monetary can realistically do about the underlying causes of the recent inflation spike. 

There seems to be at least some risk that the Fed is too busy looking in the rearview mirror to see that there may be a turn coming. It is true that headline CPI is still way above target on a year-on-year basis, but that will inevitably remain true for some months to come because so many of the high monthly prints from late last year and early this year are baked into the calculation. The last two monthly prints have been much lower, possibly signalling a change in the underlying trend. 

That being said, there are still reasons for the Fed to be cautious. First, the recent lower CPI data have been heavily influenced by one factor -- gasoline prices -- and signs of a slowdown in wider inflation pressures remain elusive.  Second, until there is clear evidence of a decline in inflation expectations, the Fed will feel it cannot afford to take its foot off the brake. 

So how much further do rates have to rise? A glance at the chart deck released today tells us that the median expectation of the FOMC members for the funds rate in 2023 is now 4.6 percent, up a startling 80 basis points from the June projection. Even for 2024, the median projection is barely below 4 percent. Evidently the FOMC believes that it will take a prolonged period of high rates to get inflation back to the target. It's getting harder to believe that this scenario is compatible with anything like a soft landing for the real economy.