Hawkish Fed Sends Strong Signal: Faster Rate Hikes and Restrictive Policy Needed to Tame Inflation
by Craig Dismuke, Dudley Carter
As expected, the Federal Reserve voted to raise its target rate by 25 bps to a range of 0.25%-0.50% and signaled the need for a more rapid pace of tightening for the remainder of the year as it seeks to slow down the fastest inflation in 40 years. The overall tone of the decision, however, was indisputably more hawkish than many anticipated. The decision was not unanimous, with St. Louis Fed President Bullard voting for a half-point hike at today’s meeting. The Statement was amended to reflect the broadening of inflation pressures beyond just the pandemic-affected sectors and the new forecast for the Fed’s preferred inflation measure was ratcheted up significantly this year and over the forecast horizon. As a result, current-year economic growth is expected to be much weaker and officials now believe they will need to rapidly chase down inflation and move policy into restrictive territory by the end of next year.
The Fed removed a caveat that certain sectors of the economy continued to be impacted by the pandemic and acknowledged the new uncertainty posed by the war in Ukraine. The geopolitical conflict is likely to suppress economic activity and “create additional upward pressure on inflation.” Notably, the description of current inflation trends reflected more concern at the Fed as higher energy prices and broadening pressures were newly listed alongside economic imbalances as factors keeping inflation high. Those inflation dynamics supported today’s rate hike and the Fed, in newly added forward guidance, said it “anticipates that ongoing increases in the target range will be appropriate.” While short on details, the Fed also noted that it expects to begin shrinking its balance sheet “at a coming meeting.”
Not surprisingly, the inflation forecast in the new Summary of Economic Projections was marked up sharply for this year and over the horizon, reflecting a belief that it will take longer for pressures to moderate back closer to target. Headline PCE inflation is now expected to average 4.3% in the fourth quarter of this year, a significant upward revision from the 2.6% rate expected in December, before moderating to 2.7% in 2023 (previously 2.3%) and a still-above-target 2.3% in 2024 (previously 2.1%). The forecast for core PCE inflation for the end of 2022 was revised up from 2.7% to 4.1% and is expected to decline to 2.6% in 2023 (previously 2.3%) before falling to 2.3% in 2024 (previously 2.1%). As a result, GDP growth in 2022 was revised down from 4.0% to 2.8% with the central tendency range down from 3.6-4.5% to 2.5-3.0%. However, despite the revisions higher for inflation in 2023 and 2024, real GDP growth was not revised lower for those years.
Against the backdrop of stronger inflation expectations, the median outlook for the path of the federal funds rate this year shifted sharply higher. The median official now expects the target range to end 2022 at 1.75% to 2.00%, up from December’s forecast for a year-end range of 0.75% to 1.00% and the equivalent of six additional quarter-point hikes this year (seven in total, including today’s increase). Seven officials projected a rate above the median 2022 year-end range while four projected a rate below the median. The median path reflects a year-end target range of 2.75% for the end of 2023 (and for 2024), indicating the possibility of three or four hikes next year. Notably, the projected path would put the target rate in restrictive territory sometime next year, above the Fed’s estimated neutral rate which was revised down from 2.50% (median) to 2.375%, the lowest since the Fed began publishing projections in 2012.
Fed Chair Powell will host a press conference at 1:30 p.m. CT. The next scheduled FOMC meeting will be held May 3-4.