The Federal Reserve raised interest rates by a half point on Wednesday in a widely anticipated move that indicates it believes that while the inflation outlook is improving, it is not yet due.
The move lower from recent 75 basis point hikes follows comments earlier this month from Chairman Jerome Powell that the central bank would start cutting the amount of interest rates going forward, though he vowed to “stay the course.” in the fight against inflation.
The next question will be how much the Fed will raise interest rates in 2023, and when it might hold the cap on future hikes or even start cutting rates if the economy goes into recession.
The Fed also updated its rate and economic projections.
It now sees gross domestic product growth in 2023 of just 0.5%, just above recession levels, while the GDP projection for this year is now also 0.5%. Those compare with September projections of 1.2% for 2023 and 0.2% for this year.
While inflation remains well above the Fed’s desired annual average target of 2%, it is slowing markedly in some areas, such as energy, used cars, durable goods, and even in troubled areas of the economy, such as salaries and apartment rents.
Political cartoons about the economy
But Powell warned that rates may stay higher for longer, depending on incoming data and the trajectory of the economy. He is aware of the times in the late 1970s and early 1980s, when central bankers eased their tightening too soon, allowing inflation to stay high.
“Whether structurally we can ever get back to 2%, that’s going to be the key question going forward,” says Steve Wyett, chief investment strategist at BOK Financial.
Some economists and corporate leaders have argued that the unusual nature of the coronavirus on the economy in 2020 and 2021, especially the disruption to office life, global supply chains, and workforce declines, help explain some of the price spikes and would recede once COVID-19 was less of a threat. To some extent, that has happened, but inflation has stayed higher for longer than anticipated and the coronavirus is not yet out of the picture.
“The Fed focuses on inflation dynamics in parts, and not all parts are on the same page,” said Odeta Kushi, deputy chief economist at title insurer First American.
Kushi notes that goods inflation rose sharply in 2021 due to supply issues and pandemic lockdowns that led consumers to spend heavily on items like furniture and sporting goods, and that it has been declining rapidly.
But, he says, “inflation in the service sector continues to rise, largely due to the housing component. Accommodation is considered a service and represents 57% of basic services in the consumer price index.
The data, however, is delayed by up to a year. And while apartment rents have been falling as measured by private online rental companies, it still doesn’t show up in government reports.
“Rent and price growth is now slowing, which means the housing component of inflation will cool; it’s just a matter of time,” says Kushi.
According to rental data compiled by Zumper for its 2022 tenant report, housing formation has slowed, occupancy is down, and apartment prices are starting to decline or turn down.
“Rental prices are almost always a harbinger of other economic indicators,” Zumper CEO Anthemos Georgiades said. “We are seeing pandemic-era trends begin to unwind and we expect that to accelerate, in almost all sectors of the economy, over the next six months or more.”
The final part of the Fed’s equation is wage growth in the service sector, and that continues to rise as companies struggle to find workers.
“It’s always hard to fight the markets,” says Nanette Abuhoff Jacobson, global investment strategist at Hartford Funds, “and the markets have staged a powerful rally.”
Both the stock and bond markets have bought into the idea that the Fed will start to slow, or reverse, its aggressive tightening next year and that inflation is under control.
But, adds Jacobson, “I think the market is too complacent.”