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HomeMarketFed Officials See Higher Rates in 2023, but the Path Isn't Clear

Fed Officials See Higher Rates in 2023, but the Path Isn’t Clear

Federal Reserve Board Chairman Jerome Powell. The Federal Reserve will be data-dependent in 2023.

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Federal Reserve officials on Wednesday raised the federal-funds rate by half a point and gave their latest policy predictions. But the outlook for the path of interest rates from here still isn’t clear. The sharp, rapid phase of policy tightening is in the rearview mirror. Now, the question shifts to how far rates will rise from how quickly.

As has been the case all year, the Fed is focused on getting inflation down from decades-high levels. Officials have taken the fed-funds rate to a target range of 4.25% to 4.50% from a hair above zero over seven meetings, which included four straight 0.75 percentage-point hikes.

Recent monthly readings have shown a slowing in housing and shelter-related inflation and a reversal in prices in several goods categories. But services inflation—which makes up more than half of the index—continues to rise. That’s closely tied to wages. 

With unemployment below 4% and job openings high, workers have leverage. It will take some noticeable weakening in the U.S. labor market for wage inflation to come down, and that won’t happen overnight.

To counter that more stubborn inflation, FOMC members expect to need to raise rates higher next year than they did a few months ago, and to keep them there for longer. Officials’ median forecast for peak interest rates in 2023 rose to 5.1% in the December Summary of Economic Projections, from 4.6% in September. 

A weaker labor market may be the conditional requirement for the Fed to declare victory and deliver its sought-after pivot in monetary policy to a reduction or at least a pause in rising interest rates, and away from tightening.

“I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way,” Fed Chairman Jerome Powell said in his postmeeting press conference on Wednesday. “That’s the test.”

In other words, the silver lining in Wednesday’s news is that Fed officials don’t need to see a 2% inflation rate in the economic data, they only need to be convinced that it’s close at hand. A labor market that puts less upward pressure on wages would be one supporting indicator. 

The thing is, there’s also no crystal ball for predicting the path of the unemployment rate in 2023. That will keep Fed watchers on their toes every month, with each report causing volatility in markets as investors and traders parse the potential implications for the Fed’s next move.

“The FOMC will continue to be guided by the data in the coming months as they calibrate the degree of restrictive policy needed to bring inflation back to the 2% target,” wrote Sarah House, senior economist at Wells Fargo, on Wednesday. “All eyes now turn to 2023 for the data needed to assess the path forward from here on monetary policy.”

It’s less of a prescriptive path than the Fed has been on in 2022. Although the big moves in interest rates are behind us, the Fed’s job isn’t done. Hikes should come in smaller increments from here, and how many of those increments remain will be a function of data. But at least the finish line is closer than a 2% inflation print.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

Credit: marketwatch.com

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