Federal Reserve Chair Jerome Powell bluntly warned in a speech last month that the Fed’s bid to curb inflation by aggressively raising interest rates would “entail some pain.” On Wednesday, Americans could get a better sense of how much pain might be in store for them.
The Fed is expected to hike its short-term interest rate by a sizeable three-quarters point for the third consecutive day at its most recent meeting. Another hike that big would push interest rates – which affect much consumer and business credit – to a range of 3% to 3.25%, the highest level in 14 years.
In another sign of the Fed’s growing concerns about inflation, it is also likely to signal that it plans to hike rates much more by the end of the year than it forecast three months ago — and keep them elevated for an extended period.
Economists expect Fed officials to forecast their benchmark interest rate could rise as high as 4% by the end of this year. They are also likely to signal further increases in 2023, perhaps up to around 4.5%.
Short-term interest rates at this level would make a recession more likely next year as the cost of mortgages, auto loans and business credit would rise sharply. The Fed intends these higher borrowing costs to slow growth by cooling a still-resilient labor market to limit wage growth and other inflationary pressures. Still, there is a growing risk that the Fed could weaken the economy enough to cause a downturn that would lead to job losses.
The US economy has not seen interest rates as high as the Fed is projecting since the 2008 financial crisis. Last week, the average fixed-rate mortgage rate topped 6%, its highest level in 14 years. Credit card borrowing costs are at their highest since 1996, according to Bankrate.com.
Powell and other Fed officials still say the Fed’s goal is to achieve a so-called “soft landing,” through which they would slow growth enough to tame inflation, but not so much as to trigger a recession would.
However, last week that target looked further out of reach after the government reported that inflation was a painful 8.3% last year. Worse, so-called core prices, which exclude the volatile grocery and energy categories, rose much faster than expected.
The inflation report also documented how far inflation has spread throughout the economy, complicating the Fed’s anti-inflation efforts. Inflation now appears to be fueled increasingly by higher wages and consumers’ steady appetite for spending, rather than the supply shortages that plagued the economy during the pandemic recession.
“They’re going to try to avoid a recession,” said William Dudley, former president of the Federal Reserve Bank of New York. “They will try to achieve a soft landing. The problem is that the scope for this is practically non-existent at the moment.”
At a news conference he is due to give after the Fed’s meeting on Wednesday, Powell is unlikely to give any hints that the central bank will ease its credit tightening campaign. Most economists expect the Fed to stop raising interest rates in early 2023. But for now, they expect Powell to step up his hard-line anti-inflation stance.
“It’s going to be a hard landing at the end,” said Kathy Bostjancic, an economist at Oxford Economics.
“He won’t say that,” said Bostjancic. But referring to the most recent Fed meeting in July, when Powell raised hopes of a possible slowdown in rate hikes, she added: “He also wants to make sure markets don’t get off and recover. That happened last time.”
In fact, investors responded by buoying stock prices and buying bonds, which lowered yields on securities such as the benchmark 10-year Treasury bond. Higher stock prices and lower bond yields generally stimulate the economy – the opposite of what the Fed wants.
At an earlier news conference in June, Powell noted that a three-quarter-point rate hike was “an unusually large one” and indicated that “I don’t expect moves of that magnitude to be common.” But after August’s alarming inflation report, the Fed now seems all but certain to announce its third straight rate hike. A fourth such increase is also possible if future inflation measures do not improve.
The central bank has already implemented the fastest series of rate hikes since the early 1980s. But some economists — and some Fed officials — argue they don’t have to raise rates just yet to levels that would actually limit borrowing and spending and slow growth.
Loretta Mester, president of the Cleveland Federal Reserve Bank and one of the 12 officials who will vote on the Fed’s decision this week, said she believes it is necessary to raise the Fed’s interest rate to “just over 4%” by early next year hold it there.”
“I don’t expect the Fed to cut rates next year,” Mester added, shattering the expectations of many Wall Street investors who had hoped for such a reversal. Comments like Mester’s contributed to a sharp fall in stock prices last month that began after Powell’s tough anti-inflation speech at an economics conference in Jackson Hole, Wyoming.
“Our responsibility to maintain price stability is unconditional,” Powell said at the time — a comment widely interpreted to mean that the Fed will fight inflation even if it requires large-scale job cuts and a recession.
Many economists sound confident that a recession and widespread layoffs will be needed to curb rising prices. Research released earlier this month under the auspices of the Brookings Institution concluded that unemployment might need to rise to 7.5% to bring inflation back to the Fed’s 2% target.
Only such a sharp downturn would reduce wage growth and consumer spending enough to cool inflation, according to a paper by Johns Hopkins University economist Laurence Ball and two International Monetary Fund economists.