Fed Turns Hawkish to Combat Inflation
by Craig Dismuke, Dudley Carter
Fed Turns Hawkish to Combat Inflation: The FOMC voted unanimously to keep its target overnight rate range unchanged at 0.00-0.25% but double the pace of reduction of its monthly asset purchases from $15 billion to $30 billion. If they are able to continue reducing purchases at this rate, their balance sheet expansion will now conclude in March, opening the door to a faster rate hike. Still citing heightened risks to the economy, “including from new variants of the virus;” the Official Statement noted “substantial” improvement in the unemployment rate and continued “elevated levels of inflation” as justifications for removing accommodation more rapidly.
Tight Labor Market: The Official Statement was revised to note that “the unemployment rate has declined substantially.” Moreover, the Summary of Economic Projections highlighted the tighter labor conditions. With the unemployment rate already down to 4.2%, participants revised their year-end unemployment forecasts lower with the median of 2021 forecasts lowered from 4.8% to 4.3%. The rate by year-end 2022 was revised down from 3.8% to 3.5%, holding at that level through 2024. With the longer-run employment rate still projected to be at equilibrium at 4.0%, this implies a tighter labor market than is sustainable in coming years.
Transitory Description of Inflation Proves Transitory: Inflation was no longer characterized as being “transitory” in the Official Statement and the reference to inflation “persistently below [the] longer run goal” of 2.0% was removed. The Statement was revised to note that inflation has now “exceeded 2 percent for some time.” Also removed was the description that inflation expectations remain “well anchored.” The Summary of Economic Projections showed the expected degree of the inflation overshoot. The median forecast for PCE inflation in 2021 was revised up from 4.2% to 5.3%, the median for 2022 was revised up from 2.2% to 2.6%, and the median for 2023 was revised up from 2.2% to 2.3%. Core PCE projections were similarly revised sharply higher with expectations that it will remain above target through at least the end of 2024.
Wholesale Revisions to Dot Plot: The dot plot, projecting participants’ views on year-end levels for the overnight rate, saw wholesale revisions higher. In the September dot plot, only nine participants expected to hike in 2022 and participants projected between two and three hikes by the end of 2023. In the December dot plot, every participant projected at least one hike in 2022 with the median view now projecting three hikes (0.75-1.00%). Every participant now expects the overnight rate to be above 1.00% by year-end 2023 with the median view projecting three additional hikes (1.50-1.75%). The median of projections for year-end 2024 increased from 1.75% to 2.125%. The median longer-run rate projection was unchanged at 2.50%.
Hawkish, As Expected, But Shy of Quarterly Hikes: The results, collectively, imply the Fed is comfortable running a pressure-cooker economy through at least the end of 2024 with an unsustainably tight labor market, above-target inflation, and accommodative monetary policy. Against this backdrop, the Fed was expected to turn more hawkish. However, their median projections show them stopping short of projecting a quarterly pace for future rate hikes.