MNI: Fed Sept Projections To Show Higher Rate, Inflation Peaks

Federal Reserve officials next week are set to boost their projected interest rate path for this year and next, and the revision may not be their last after an unexpected acceleration in CPI renewed fears that the fight against inflation will take longer than anticipated, former officials and staffers told MNI.

The Fed's quarterly update to its Summary of Economic Projections is likely to show rates rising to 4% or above by year-end and peaking at around 4.5% in 2023, the former officials said, though many believe rates will ultimately need to rise to 5% or higher, more than futures markets are pricing. Fed funds implied rates peak in March 2023 at 4.48%, just a tad above 4.25% in December.

"It's quite plausible we get to 4% by year-end, and I would not rule out a decision to go higher than 4%," former Atlanta Fed president Dennis Lockhart said. "A negative scenario that sober observers have to consider is one in which there's no tangible progress in taming inflation over the coming months and past year-end."

Both headline and core CPI accelerated in August as food prices surged and owners' equivalent rent notched its largest increase since 1986, giving the Fed no reason to dial back the pace of interest rate hikes. A third straight 75-basis-point rate increase next week will take the fed funds rate to a 3%-3.25% target range for the first time since 2008.

NOT QUITE RESTRICTIVE

The 3.8% peak in rates seen in the Fed's June economic projections "was predicated on inflation coming down at under 3%, and that looks really dubious at this point," said former Richmond Fed president Jeffrey Lacker, who expects to see a more hawkish rates path accompanied by higher inflation forecasts next week.

"If inflation expectations remain about where they are at 5% or 6%, they’re going to have to go up above 6%. Maybe on their march there by the time they get there expected inflation will ease off a little bit. But it seems unlikely it will ease off enough to warrant stopping before 5%."

Former Dallas Fed principal policy adviser Evan Koenig agreed there was nothing in the August CPI report to suggest that underlying inflation pressures are easing. Core CPI seems to be stabilizing at around 6% rather than heading lower, he noted, while the Dallas Fed's Trimmed Mean PCE inflation gauge estimates the underlying trend for the Fed's preferred price measure to be somewhere between 4.25% and 4.5%.

"Roughly speaking, we’re halfway to where we need to be to get the real funds rates to restrictive territory," he said. Unless the fed funds rate is above that trend inflation rate, "policy still isn’t in clearly restrictive territory, and until that happens, we’re not likely to see a slowing in nominal spending growth, much less in core inflation."

GRIMMER REALITY

The FOMC will likely also take this opportunity to admit that tighter monetary policy will work by driving up unemployment a little bit, though GDP forecasts aren't likely to dip below 1% so as to avoid signaling a recession, said Jonathan Wright, a former economist at the Fed board of governors.

"Tighter policy, a higher peak, lower GDP growth and higher unemployment" is a story that fits together, he said. "They'll probably put down something in the mid-4s, maybe 4.5% for unemployment, but I think that is the best case scenario. I would think that a reasonable best guess of what kind of unemployment rate you're going to take to get inflation under control would be about 5% and it could be higher."

With strong consumer demand and a Fed that has "dilly-dallied for the past year," former Philadelphia Fed economist and University of Richmond professor Dean Croushore worries inflation will gather more momentum, forcing policymakers to hike more and faster next spring.

"If they tighten sooner rather than later, the fed funds rate may not need to be much above 5%. But if they slow down and take their time, then inflation will rise more, and they will need to get up to 6% or more by mid-year next year."