December 6, 2023

WASHINGTON, DC – JUNE 21: Federal Reserve Chairman Jerome Powell testifies before the House Financial Services Committee on June 21, 2023 in Washington, DC. Powell testified at the hearing on the Fed’s semi-annual monetary policy report. (Photo by Winn McNamee/Getty Images)

Win McNamee | Getty Images News | Getty Images

The Federal Reserve is expected to approve its 11th rate hike since March 2022 on Wednesday, despite the improvement in inflation.

Investors are hoping this will be the last for a long time.

Markets are pricing in an absolute certainty that the Fed will approve a 25 percentage point rate hike, bringing the benchmark borrowing rate to a target range of 5.25%-5.5%. That would push the cap on the federal funds rate to its highest level since January 2001.

A more pressing question will be whether FOMC officials believe they have done enough, or whether more can be done to fight hyperinflation.

“The signal could be, yes, we’re raising rates, but then we think we can sit here for a while and see,” said Kathy Jones, Schwab’s chief fixed income strategist. “But there’s no commitment. They can’t let go of that option.”

In fact, the Fed’s course is far less certain. Central bank policymakers are nearly unanimous that inflation is too high, but further rate hikes from here pose risks for an economy that many believe is at least headed for a mild recession.

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The market doesn’t seem to mind, though. Wall Street has had a strong year, with the Dow Jones Industrial Average up more than 5% in the past month alone. This may be because traders ignored the Fed’s comments and saw only a 35% chance of another rate hike before the end of the year. CME Group’s Fed Watch A measure of futures market pricing.

A sticking point at the meeting will be whether Fed Chairman Jerome Powell says that, at least, the FOMC will skip raising rates again at its next meeting in September, while analyzing the impact of previous hikes on the economy. Powell said the Fed would not fall into a pattern of raising interest rates at every meeting, but he said the pace of rate hikes could slow.

“Wednesday’s rate hike was unnecessary, and the last few hikes are probably unnecessary,” said Luke Tilley, chief economist at Wilmington Trust Investment Advisors. “It will become clearer in November.”

repeat history

Still, Fed policy is based on the belief that it is better to do too much than too little to fight inflation. The current round of price increases is the worst the US and many other developed countries have faced since the early 1980s.

That last period is also behind much of the Fed’s thinking, notably how policymakers gave up on the inflation fight prematurely, ultimately leading to far worse problems.

“It’s easy for me to say I think they’re doing too much,” Tilly said. “But I’m also quick to say that if I were in their seat, I would probably do the same thing, because they really are playing the risk management game.”

The game is familiar by now: A quick retreat from the inflation fight could lead to a repeat of the high price stagflation and weak growth of the 1970s and early 1980s, while going too far could tip the country into recession.

Recent indicators suggest that credit conditions are tightening markedly, with rising interest rates and tighter lending standards posing a significant headwind to future growth.

“Powell will welcome the recent softness in core inflation, but he will likely want to see a few more months of weak inflation data before confidently ending the rate hike cycle,” Andrew Hollenhorst, an economist at Citigroup, said in a note to clients. “We do not think the U.S. economy is headed for a soft landing. After an expected softness in core inflation data over the summer, we see renewed upside inflation risks in the fall.”

Likewise, Steven Blitz, chief U.S. economist at Globaldata.TSLombard, said it would be a mistake for the Fed to “do a modest rate hike and talk about a soft landing” at Wednesday’s meeting.

“The plane lands, but the economy doesn’t. The economy is an ongoing dynamic, and no recession is a bigger problem for the Fed,” Blitz wrote. “The economy is headed for a recession, but if it can be avoided somehow, this moment of deflation will be fleeting, and the Fed believes they are at the tail end of their rate hike cycle.”

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