MNI: Fed Dot Plot To Show 1 More Hike, GDP Boost- Ex-Officials

Federal Reserve officials are likely to pencil in another interest rate hike and stronger economic growth for this year in the FOMC's updated quarterly forecasts Wednesday, hedging bets on additional tightening in case inflation proves more persistent than policymakers project, former Fed officials and staffers told MNI.

It's unclear whether the FOMC will significantly alter its June projection for 100 bps of cuts in 2024, though there is a desire to convey a "higher for longer" message, the former officials and staffers said.

“We should expect to see in the SEP and in the rhetoric a bias toward overshooting versus undershooting. Another thing that will come through is there really is no multi-meeting strategy at this point – it’s truly meeting-by-meeting and data dependent,” said ex-Atlanta Fed President Dennis Lockhart. “The size of cuts projected for next year could appear again or it could shrink. They could begin to show holding for longer if only to be conservative and cautious.”

“My best guess is the numbers in favor slip, but still a majority” will expect one more rate hike this year, said William Dudley, former New York Fed president.

A growing number of central bank officials have been indicating the Fed could be done raising borrowing costs after raising the federal funds rate 525 basis points from effectively zero to a 22-year high, but the majority are likely to keep additional tightening in their forecast.

REASONS TO HIKE

August CPI, which came out during the Fed’s blackout period last week, was a tad worse than expected with core prices adding 0.3% on the month.

“To the extent that the CPI news had any effect, it might be to reinforce conviction that it’s worthwhile to leave that rate hike in the forecast,” said Steve Kamin, a former economist at the Fed board of governors. The CPI “kind of looked like a bit of a slackening of the pace of disinflation that we’ve been enjoying in recent months."

Another reason to keep the window open to additional tightening is that markets will likely rush to price in cuts if the Fed signals it’s done.

“The market would be quite surprised, and it would raise in some sense the bar for the committee to approve a hike,” said Joseph Tracy, a former senior adviser at the Dallas Fed.

Investors are looking for cuts sooner than Fed officials expect to deliver any. "They certainly won’t ratify that, but it also may be awkward to increase the disagreement,” said former Fed Board economist Joseph Gagnon.

GROWTH BOOST

FOMC members are likely to nod to the economy’s surprising underlying strength by bolstering their views for GDP growth.

“I’d expect faster 2023 growth, 1%-plus, about the same on inflation and a lower unemployment rate for 2023 and 2024. So somewhat greater lean towards a soft landing story,” Dudley said. The June SEP saw 1% growth for 2023 and 1.1% in 2024.

Dean Croushore, a former Philadelphia Fed economist, says he expects another rate increase in the face of such a rosy outlook, but not at the September meeting.

“I think the SEP will show one more by the end of the year. The PCE forecast could go down just a bit, as things do look better on that front, and GDP growth should go up in the projections by a bit, as well,” he said.

Lockhart said the central bank can “overlook” robust growth as long as inflation appears to be coming down.

“Notwithstanding strong growth, we’re still seeing a gradual but acceptable pace of disinflation, and that’s most important,” he said. "The reason for the focus on the growth numbers is they raise doubt about the inflation numbers. As of now you can say the disinflation story continues to hold. We’re not seeing a strong correlation between growth and inflation now.”

GAZING AT THE R-STARS

Investors are also keeping a close eye on whether Fed officials are starting to think some of the post-Covid changes to the economy might have permanently raised the neutral rate of interest.

“I could see a small gradual rise in r-star, but not all the way back to 2010 levels,” said Gagnon.

For that reason, markets will be homing in on Fed estimates of the long-run policy rate as a gauge into whether officials believe we’ve entered a new, higher inflation and rate regime. (See MNI POLICY: Lively Debate At Fed Over Possible R-Star Rise)

“If it moves up further, expect change to be very modest. But definitely something I will be checking,” Dudley said.