The latest research, conducted in collaboration with the Initiative on Global Markets at the University of Chicago’s Booth School of Business, suggests the Federal Reserve is far from over in its campaign to tighten monetary policy. It has already raised interest rates this year at the most aggressive pace since 1981. After hovering near zero as recently as March, the federal funds rate now hovers between 2.25 percent and 2.50 percent. The Federal Open Market Committee reconvenes on Tuesday for a two-day policy meeting, in which officials are expected to implement a third straight rate hike of 0.75 percentage points. This move will lift the interest rate to a new target range of 3% to 3.25%. Nearly 70 percent of the 44 economists surveyed between Sept. 13 and 15 think the Fed Funds rate this tightening cycle will peak between 4 percent and 5 percent, with 20 percent thinking it should to pass this level. “The FOMC still hasn’t come to terms with how high they need to raise rates,” said Eric Swanson, a professor at the University of California, Irvine, who predicts the Fed funds rate will eventually rise above 5 percent to 6 percent. one hundred. “If the Fed wants to slow the economy now, it needs to raise the funds rate more [core] inflation.”
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While the Fed typically targets a 2 percent rate for the “core” personal consumption expenditures (PCE) price index — which strips out volatile items such as food and energy — it also closely monitors the consumer price index. Inflation picked up unexpectedly in August, with core rising 0.6 percent for the month, or 6.3 percent from a year earlier. Most respondents project core PCE will fall from July’s most recent level of 4.6 percent to 3.5 percent by the end of 2023. But nearly a third expect it to exceed 3 percent 12 months later. Another 27 percent said it was “about as likely as not” to remain above that threshold at the time – suggesting a strong concern about high inflation being more deeply embedded in the economy. “I’m afraid we’ve reached a point where the Fed faces the risk of serious erosion of its credibility, and so it needs to start being very aware of that,” said Jón Steinsson at the University of California, Berkeley. “We all hoped that inflation would start to come down, and we’ve all been disappointed again and again and again.” More than a third of economists polled warn that the Fed will fail to adequately control inflation if it does not raise interest rates above 4 percent by the end of this year.
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Short of raising interest rates to a level that limits economic activity, most respondents expect the Fed to keep them there for a sustained period. Easing price pressures, financial market volatility and a worsening labor market are the most likely reasons the Fed will end its tightening campaign, but a Fed Funds rate cut is not expected until 2024 at the earliest, according to the 68% of respondents. Of those, a quarter don’t expect the Fed to cut its key interest rate until the second half of 2024 or later. Few believe, however, that the Fed will increase its efforts by shrinking its nearly $9 trillion balance sheet through outright sales of its mortgage-backed securities. Such aggressive actions to loosen the economy and root out inflation would come at a cost, a point made by President Jay Powell in recent appearances.
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Nearly 70 percent of respondents expect the National Bureau of Economic Research—the official arbiter of when U.S. recessions begin and end—to declare one in 2023, with most expecting the former or the second trimester. That compares with about 50 percent who see Europe heading into recession by the fourth quarter of this year or sooner. A U.S. recession is likely to last two or three quarters, most economists estimate, with more than 20% expecting it to last four or more quarters. At its peak, the unemployment rate could hover between 5 percent and 6 percent, according to 57 percent of respondents, well above the current level of 3.7 percent. A third see it eclipsing 6%. “That’s going to fall on workers who can’t afford it when we have increases in unemployment because of these rate hikes at some point,” warned Julie Smith at Lafayette College. “Even if it’s small amounts — one or two percentage points of unemployment growth — that’s real pain for real households that aren’t prepared to deal with those kinds of shocks.”
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An easing of supply-side constraints related to the war in Ukraine and Covid-19 lockdowns in China could help minimize how much the Fed needs to reduce demand, meaning a less severe economic contraction in end,” said Şebnem Kalemli-Özcan at the University of Maryland. However, he warned that the outlook is extremely uncertain. “Obviously this is one shock after another, so I’m not sure this will happen right away,” Kalemli-Özcan said. “I can’t tell you a timeline, but it’s going in the right direction.”
