Fed Sends Strong Signals on Future of Inflation, Interest Rates, and Employment

Despite the aftershocks from SVB and Signature Bank failures still reverberating from the economy, the Federal Reserve pressed on with its strategic interest rate hiking campaign, adding another quarter point increase when they met last week.

‍

Given that rate increases were in part to blame for the financial turmoil that catalyzed the initial bank run at SVB, and given that the Fed had already increased the rate 7 times last year amounting to more than 5 points of additional interest in total, most forecasters were expecting somewhere between zero and a quarter point hike, so the Fed again delivered an outcome on the more aggressive end of the prediction range.

‍

Perhaps even more importantly than the announced hike, however, were some of the insights into the thought processes that are driving current Fed strategy as well as providing further clarification and updates on the benchmarks and timeframes that are guiding their actions.

‍

First, the Fed response had a noteworthy shift in language and tone when it noted that 'some additional intervention in the form of rate hikes may be necessary', which is considerably less definitive than previous declarations from the Fed, which described its policy of rate hikes as 'ongoing'. 

‍

The Fed also made known that they anticipated interest rates to hit 5.1% by the end of 2023 which is a little more than a quarter of a point above current levels, so it’s fair to assume another quarter point or so increase over the next 9 months, which is inline with the ‘pause’ language the Fed used and also explains the emphatic attempt to distinguish a pause from a complete stop.

‍

Another major point that Fed Chair Jerome Powell drove home was his awareness of the costs associated with maintaining interest rates at current levels or higher. In continuing the course as currently plotted, the Fed expects the unemployment rate to climb from its present level of 3.6% all the way to 4.5% by year’s end, which correlates to 1 million additional unemployed workers and all the accompanying problems and sacrifices that come along with the workforce taking that kind of hit. 

‍

Still, in response to a question about a possible unemployment snowball effect that could result from applying that kind of upward pressure on the unemployment rate, Powell remained steadfast - even though the Fed itself may not be equipped with the necessary tools to contain that pressure should it build up in excess. 

‍

Instead of dismissing the possibility of an unemployment spiral, Powell simply reiterated that returning to a stable 2% annual increase in inflation is the number one goal that the Fed is unequivocally prioritizing, as they believe that not doing so would lead to even worse outcomes.

‍

Some changes that Powell would like to see, on the other hand, are changes in the regulatory systems that failed to flag and adequately address the problems at SVB and Signature before it was too late to do so at which point more dramatic intervention became the only viable response that regulators had left.

‍

Beyond advocating for the general proposition that strengthened oversight mechanisms are necessary to prevent similar liquidity and interest rate exposures from getting out of control in the future, Powell stopped short of providing any particular insight about how best to accomplish that goal, adding it’s “inappropriate for [him] at this stage to offer [his] views on what the answers might be.”

‍

While any current plan of action that the Fed intends to implement is always highly subject to change as conditions within various markets and subsets of the economy adjust to an ever-shifting landscape, the latest responses from the Fed paints a clearer picture of just how tightly they are clinging to their previously proclaimed intention of continuing with the rate hike agenda in the months to come.

‍

While that intention has apparently softened in the face of significant economic events that many thought would lead to a much more dramatic shift in course, the Fed clearly intends to at the very least maintain interest rates at current levels, and has no intention of bringing rates down this calendar year, much to the dismay of a great many investors who thought rates would be down by half of a point or more within the calendar year.

‍

While rates coming down may be an inevitability of sorts, the latest signals coming out of the Fed certainly reinforce the idea that we shouldn’t be expecting any decreases in the near future.

You can read more about this analysis of inflation, interest rate hikes, and unemployment here.