Federal Reserve officials gave their clearest signal yet that they are willing to tolerate a recession as the compensation needed to regain control of inflation.
Policymakers were criticized for being too late to realize the size of America’s inflation problem. Policymakers are moving aggressively to catch up. They raised interest rates by 75 basis points on Wednesday for the third time in a row. And forecast another 1.25 percentage points of change before the end of the year.
That was more aggressive than economists expected. In addition, officials cut growth projections and raised their unemployment prospects. Chairman Jerome Powell repeatedly spoke of the painful slowdown needed to curb price pressures. It is running at the highest levels since the 1980s.
“Powell’s admission that there will be below-trend growth over a period should translate to the central bank talking about ‘recession,'” said Seema Shah of Principal Global Investors. “Times are going to get tougher from here.”
To be clear, Fed officials are not projecting a recession. But Powell’s rhetoric about rate hikes is likely to cause pain to workers. Businesses have become sharper in recent months. On Wednesday, at his post-meeting press conference, Powell said a soft landing with only a small increase in unemployment would be “very challenging.”
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“No one knows if this process will lead to a recession or, if so, how significant that recession would be”. Powell told reporters after officials raised the target range for their benchmark rate to 3% to 3.25%. “The chances of a soft landing are likely to diminish to the extent that the policy needs to be more restrictive or restrictive for longer. However, we are committed to bringing inflation back down to 2%.”
That sober assessment is in stark contrast to six months ago when Fed officials began raising rates from near zero and pointed to the economy’s strength as a positive. It would be something that would protect people from feeling the effects of a cooling economy.
Officials now acknowledge, through their more pessimistic unemployment projections. Demand will have to be reduced at all levels of the economy, as inflation has proven to be persistent and widespread.
The average forecast among the 19 Fed officials is for unemployment to reach 4.4% next year and remain there until 2024, from the current rate of 3.7%. But even that new level might be too low. Nearly all participants said the risks to their new forecasts were weighted higher. They projected interest rates to reach 4.4% this year and 4.6% in 2023, before moderating to 3.9% in 2024.
“We have always understood that restoring price stability while achieving a relatively modest rise in unemployment and a soft landing would be very challenging,” Powell said Wednesday. “We have to get inflation behind us. I wish there was a painless way to do it. There isn’t.”
The apprehension of Fed officials about their ability to reduce inflation is also evident in other projections. Even amid a new rate hike path, officials still don’t see inflation slowing to its 2% target through 2025.
If they privately suspect that this means the risk of recession is increasing, they are not saying it out loud.
“I think they understand it’s increasing, even though it’s not yet their goal,” said Laura Rosner-Warburton, senior U.S. economist at research firm Macro Policy Perspectives LLC in New York. “The soft landing or not is out of their control and depends on factors such as improved supply, which they can’t trust or wait for.”
Powell told reporters several times that a softer labor market may be necessary to sufficiently reduce demand. But he also pointed to higher savings rates and more money at the state level, indicating that the economy remains reasonably strong, a “good” thing he said would make it more resilient to a significant recession.
That was met with skepticism.
“There has never been a half-percent increase in unemployment without a recession,” said Roberto Perli, head of global policy research at Piper Sandler & Co. “So it’s very likely. They know it. History says it doesn’t normally happen.”
Perli sees further increases of 75 basis points in November, followed by a half-point increase in December. Several economists raised their forecasts on Wednesday about where Fed rates would peak.
Bank of America Corp. now sees increases of 75 basis points in November, 50 basis points in December, and two-quarters of a point increases in early 2023, bringing the Fed’s benchmark rate to a target range of 4.75% to 5%. Economists at Societe Generale SA are calling for a “mild recession” in early 2024.
Stephen Stanley, the chief economist at Amherst Pierpont Securities, raised his terminal rate outlook to 5.25%, saying he doesn’t think the Fed’s inflation forecasts are realistic and that further adjustment will be needed to reduce price growth.
“I see the first half of next year as a treacherous time for the Fed,” Stanley wrote in a note.
Whether the Fed finally stops at its current forecast of 4.6% or goes up, its tighter policy will bring job cuts, according to Bloomberg’s chief U.S. economist Anna Wong. Raising rates to 4.5% would cost about 1.7 million jobs, and rates to 5% would mean 2 million fewer jobs, he said.
Powell acknowledged that rates may have to be higher than currently expected.
“We’ve written down what we think is a plausible path for the federal funds rate,” he said. “The path we execute will be enough. It will be enough to restore price stability.”
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