FOMC Statement and Powell’s Press Conference
December 14, 2022
The FOMC statement and projections conform to market expectations. The federal funds target increase got reduced to 50 basis points after four straight 75-bp incremental rises. The cumulative increase is now425 basis points since the opening increase last March of 25 basis points. The new federal funds target range of 4.25/4.50% is the highest in fifteen years, and an additional 75 basis points of tightening in 2023 is deemed likely to be needed. Balance sheet reduction will continue as outlined previously. The U.S. economy is characterized as stagflationary with elevated inflation but only modest growth in output and demand. Robust employment growth with low joblessness has boosted wage growth. Officials recognize that previous progressive monetary tightening will exert ongoing restraint on growth and inflation and will take that reality into account in setting future monetary policy. Projected economic growth in 2023 was more than halved to 0.5% (leaving the door open but not explicitly predicting) a recession next year. Growth picks up in 2024 and 2025 but doesn’t reach 2% in either year, according to updated forecasts that foresee a higher future inflation path than imagined in the previous forecasts released in September. The PCE price deflator is expected to climb 3.1% next year, 2.5% in 2024, and 2.1% in 2025. This could enable officials to lower interest rates by a percentage point in 2024 and again in 2025…..
Chairman Powell’s press conference toggled back and forth between offering some good news but cautioning that a long time still remains before the mission to restore price stability (i.e., sustained 2% inflation as defined by the core personal consumption expenditure price deflator). The good news is that the significant disinflation of goods price inflation, which Fed officials had been expecting to see earlier, is finally happening. Also, there are beneficial developments in housing service prices that point to a reduction of that component next year. The challenge remain in non-housing services, where prices depend almost exclusively on labor market conditions that remain extremely tight. Moreover, this third element of the PCE deflator represents a little more than half of the PCE. Average hourly earnings rose 6% over the past year, three times the Fed’s price target, and overall inflation, although down from peak is higher at the end of 2022 than was anticipated earlier. Officials are in agreement that it will take a more restrictive monetary stance to restore price stability in a sustainable way.
Where this leaves monetary policy going forward is that interest rates and the overall policy stance have not become sufficiently restrictive yet. Also, the peak in rates will be higher than assumed earlier, and the length of time that is likely to elapse between the last rate hike and the first cut will likely be more elongated that assumed previously. A federal funds rate of 3.1% at end-2025 (which is the average expected level among the 19 FOMC members) would be a little more than a half percentage point above the considered long-run neutral level. But that’s getting ahead of the current direction, which will remain upward for some time longer. The good news here appears that since 425 basis points of monetary restraint are already in the pipeline, since the rate level is now already restrictive, and since the last couple of inflation reports suggest that inflation may have peaked, officials will become more cautious in regard to the size of each future rate hike. It was cut from 75 bps to 50 bps, and it’s possible that the pace will be throttled down further in 2023.
Given the additional duration of a restrictive monetary policy and the fact that inflation is still way above target, many questions at the press conference tried to tease out of Powell an indication of how likely a recession in 2023 appears and how severe such a downturn might me. He avoided any definitive indication, implied that the key is likely to lie in the behavior of wages, and reaffirmed that the nation would suffer greater pain if central bank policy began to ease before Fed officials are confident that price stability as defined will be met.
Copyright 2022, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: FOMC Statement and Powell press conference in December 2022
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