Ken Matheny, executive director, U.S. Economics, S&P Global Market Intelligence, said in this commentary available exclusively to Electrical Marketing subscribers that he expects the Federal Reserve to continue fighting inflation with rate hikes until it’s lowered much closer to 2% on a sustained basis.
“The Federal Reserve will act as if it’s almost single-mindedly focused on inflation,” Matheny said in his post. “It sees slaying inflation as the defining challenge of this episode. It will tolerate, even expect, a period of economic softness and higher unemployment as the price to pay to bring inflation down.”
Following is the rest of his take on the Federal Reserve’s strategy to bring down inflation.
The Federal Reserve’s move to raise interest rates by 75 basis points to a range of 3% to 3¼% this week, was the third consecutive increase of that magnitude. The Fed’s decision for another large rate hike is based on the still very worrisome data on actual inflation. S&P Global Market Intelligence believes expectations for sluggish GDP growth and hints of moderation in the pace of employment gains did not deter the Federal Open Market Committee (FOMC) from announcing another large rate hike. Indeed, there was some speculation that policymakers would hike interest rates by an unprecedented 100 basis points this time in attempt to signal in the most forceful manner its determination to see inflation brought down quickly.
Inflation declines expected
We anticipate that several factors will give rise to a sustained and substantial decline of inflation over the next few years, which underpins our expectation that the Fed will continue hiking interest rates through the end of this year, then pause for about one year before beginning to reverse course and lower interest rates. On a four-quarter basis, we expect core PCE inflation to end this year at 4.5%, down from a peak earlier this year of 5.2%. It will continue to ease, falling to 2.7% in 2023 and 2.2% in 2024, and even lower in subsequent years. Mostly well-anchored long-term inflation expectations, improvements in supply chains, some easing in prices for commodities and moderation of demand to bring it in better alignment with improving supply contributes to the reduction of core inflation. Headline inflation will fall faster and from a higher peak, largely due to continued declines in energy prices in coming quarters.
Looking beyond September
The Fed will continue to push the brakes hard and with both feet until there is a string of low inflation reports. The rate hike of 75 basis points this week could put the Fed on track to lift the upper end of the target range for the federal funds rate to about 4% by December. S&P Global Market Intelligence assumes that 4% will prove to be the peak for the funds rate target. We expect the FOMC to hold the funds rate target at 4% for one year and anticipate it will begin to consider lowering interest rates in late 2023, at which point we project that annual core inflation will have declined to less than 2¾% and monthly readings will point to further declines to near 2%.
However, there is a risk for an even higher trajectory for the Fed’s policy rate. The most salient risk is that inflation might not moderate as quickly anticipated. The FOMC will not pause with rate hikes until it sees compelling evidence that inflation is moderating substantially and sustainably, and it will not begin to lower interest rates until it is convinced that inflation is firmly headed to 2%. Any delay in meeting those criteria would cause policymakers to consider raising the target funds rate above 4% and could push back the start of rate cuts until after 2023.