Will the Fed raise interest rates in 2023? Yeah. Higher heights are expected.
Federal Reserve officials predicted last week that they would need to raise interest rates more than they previously planned in 2023 to bring down inflation.
Increasing federal interest rates increase the cost of borrowing money to buy a car or house and carrying a credit card balance. They also create a more volatile stock market that can hurt the 401(k) plans of millions of Americans.
So how high will interest rates go in 2023? Some top economists and markets don’t think they will rise as high as the Fed expects. Here’s why.
How much was the Fed rate hike?
The Fed’s final rate hike this year, while historically large at half a percentage point, was an undoing of four consecutive three-quarter point hikes.
In other words, the Fed is slowing the pace of this year’s flurry of interest rate increases, which are intended to curb soaring inflation. This would better allow the central bank to assess the effects of aggressive moves, including whether they are about to push the US into recession next year as most economists expect.
On Wednesday, Fed officials projected a three-quarter-point overall increase in rate increases in the coming year before pausing, bringing the benchmark rate to a peak of around 5.1%, much higher than the 4.3% today and the 4.6% peak rate they expected in September. .
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Federal Reserve Chairman Jerome Powell said the Fed has “a ways to go” before taking a break and keeping interest rates steady.
Is inflation expected to decrease?
For some economists, the hawkish stance seems at odds with reports showing inflation has eased more than expected over the past two months.
Consumer prices rose 7.1% annually in November, down from 8.2% in September and a 40-year high of 9.1% in June, according to the Consumer Price Index. This is still well above the Fed’s 2% target but is a sign of progress.
However, the Fed revised its forecast for another measure of inflation at the end of 2023 by three-tenths of a percentage point to 3.1% and the “core” reading that excludes volatile food and energy by about half a point to 3.5%.
“What data are they looking for?” asks Tom Porcelli, chief economist at RBC Capital Markets.
Even the futures market, which usually predicts interest rate movements, does not believe the Fed. Figures suggest the Fed will hold interest rate increases at around 4.8% as inflation eases again and the economy deteriorates, according to CME Group.
Why is the stock market going down?
Meanwhile, the S&P 500 is down about 4% since the Fed’s announcement, giving up much of its 7.5% gain over the previous six weeks, fueled largely by encouraging inflation reports and hopes the Fed will be less aggressive.
Higher rates mean more pain for the economy and corporate earnings and motivate investors to move money from stocks to less risky bonds.
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Why does the Federal Reserve keep raising interest rates?
Powell says the Fed welcomes the recent easing of inflation, but needs to see “significantly more evidence” that “inflation is on a sustainable downward trajectory.”
Powell said that while inflation for goods such as used cars and furniture eases with declining supplies, prices for services such as restaurant visits continue to rise sharply due to a persistent labor shortage that forces employers to increase wages and thus raise prices.
In November, employers added 263,000 healthy jobs and average hourly earnings increased 5.2% annually, up from 4.7% in the previous month.
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Jonathan Millar, chief US economist at Barclays, buys Powell’s argument.
“It’s hard to see a strong job market resulting in 2% inflation,” Millar says.
In other words, while inflation has fallen, Fed officials don’t necessarily believe the trend will continue. And so they feel they should raise interest rates higher than planned to make it more expensive for employers to borrow money for hiring and investment, thus limiting job growth and increasing wages.
Does the Fed want or need much less inventory?
Some economists think the Fed is more worried about a booming stock market and long-term interest rates that have fallen sharply as inflation subsides.
A vibrant stock market makes consumers feel richer, which leads them to spend more. And long-term, lower rates — like mortgages — lead consumers and businesses to borrow and spend more.
Such developments support the economy but may increase inflation. As a result, the theory goes, Fed policymakers aren’t really pessimistic about inflation and the path of interest rates. They just need to say that they are in order to weaken the market and borrowing costs, which helps lower inflation.
“It’s difficult to know whether Fed officials really believe their own projections, or whether they are trying to reverse some of the easing in financial conditions over the past month,” economist Paul Ashworth of Capital Economics wrote in a note to clients. .
What will the economy look like in 2023?
Some economists are also baffled that the Fed’s inflation forecasts don’t seem to align with its economic projections.
The Fed expects the economy to grow just 0.5% next year, weaker than the 1.2% it forecast in September. It estimates that the unemployment rate of 3.7% will rise to 4.6% by the end of next year, above the 4.4% previously estimated.
Typically, a weak economy and high unemployment lead to lower inflation because fewer shoppers buy products and fewer employers hire, which limits wage increases.
“These inflation numbers are difficult to adjust,” Porcelli wrote in a note to clients.
However, Millar points out that the traditional model that higher unemployment means lower wage and inflation increases, and vice versa, has not held true in recent years. As a result, he says, it may take a much higher unemployment rate to rein in inflation.
How far will the Fed raise interest rates in 2023?
So what will the Fed do next year?
Despite his predictions, economists expect the central bank to stop raising interest rates sooner if inflation continues to ease and the economy weakens in the coming months.
“We think that a slowdown in the economy and progression in inflation will allow the Fed to stop living up to those expectations,” says economist Nancy Vanden Houten of Oxford Economics. It is looking for another quarter-point rate hike in February, which would raise the rate to 4.6%.
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