Fed Ups Inflation Forecast, May Raise Rates In Late 2022

Central bankers like to move slowly and predictably. However, today’s announcement did signal a fairly large incremental adjustment to the Fed’s thinking.

First off, the Fed updated their inflation outlook to exceed 4% in 2021, though arguably in keeping with the transitory inflation thesis, the Fed sees inflation much closer to 2% in 2022. Most recent inflation data has lent some support to the Fed’s view. However, the Fed’s forecasts do leave room for inflation to remain around 5% for the remainder of 2021.

A Rate Hike In 2022?

The Fed has said it’s looking to raise rates when two conditions are met. First off, they want the labor market back to maximum employment. Secondly they want inflation at or moderately above 2%.

Now, second half of that test is already met. Inflation is at 5%. Of course, inflation may trend down, and the Fed expects it to, but few see it going under 2%.

That then throws the emphasis onto unemployment. For August 2021, the U.S. unemployment rate was 5.2%. However, going into the pandemic unemployment was in the mid 3% range.

Unemployment

Therefore, the Fed wants to see lower unemployment before rates are lifted. The Fed’s current forecasts have a 3.6% to 4% unemployment in 2022, which for about half of policy-makers is sufficient to start to raise rates. All but one of the Fed decision makers have rates going higher in 2023. So late 2022 or early 2023 appear to be when the Fed expects to start raising rates if current trends continue.

That said, the employment situation is interesting at the moment. On the one hand certain parts of the labor market such as retail are tight, but other sectors such as travel and leisure show more slack, disrupted by the Delta variant. The Fed is confident that this dynamic will work itself out over the coming months.

Tapering Is Close

Powell is looking to build consensus for a tapering move in the Fed’s asset purchase. Many on the Fed committee are already there, Powell himself is very close. He stressed that the test for tapering is much lighter than the test for lift-off with tapering quite possible at the Fed’s scheduled November meeting.

One mild concern is the ongoing debate on the raising of the U.S. debt ceiling, which is expected to be needed next month, and could be disruptive to markets should that not occur.

Market Reaction

Despite drift leading into the announcement, stocks were relatively unfazed by the Fed’s announcement today. In part this is because if unemployment does reach the low levels that the Fed is looking for to raise rates, that will be a positive for many firms. If the Fed is in a position to lift rates, they should be seeing a good progression for the pandemic recovery. However, if rates do continue to rise into 2023, that would be a greater concern for markets.