MNI INTERVIEW: FOMC Opens Door To 5% Rates and Beyond In 2023

This week’s FOMC decision represents a reset of Fed policy to decisively communicate to markets that economic weakness -- even a recession -- will not dissuade the Fed from hiking interest rates to control inflation, former Dallas Fed adviser Danielle DiMartino Booth told MNI.

The Fed not only jacked up borrowing costs by 75 basis points for a third meeting in a row but also signaled a much higher peak for rates – up to a 4.6% median from 3.8% in June -- with a third of officials estimating an even higher peak rate of 4.9%.

“By pushing out the terminal rate and by repeatedly saying we’re not just going to get to 5%, we’re going to get to 5% and stay there, they completely shifted the dialogue,” she told MNI’s FedSpeak podcast. “This was something bigger than Jackson Hole because it was portrayed as being an institutionally wide, accepted new regime."

Chair Jerome Powell’s press conference also reinforced his Jackson Hole message that economic pain would be needed to bring inflation, which rose 8.3% in August as measured by the CPI, back toward the Fed’s 2% target.

"The 0.2% GDP forecast for the entire year of 2022, that’s as close as the Fed is going to get to saying we’re in recession, and we’re going to hike more than you think we’re going to hike in recession.”

BREAKING THE FED PUT

Powell is chasing lagging indicators like inflation and the jobless rate because his real intent is to properly, unequivocally, tighten financial conditions, said DiMartino Booth, CEO and chief strategist at Quill Investment.

“Powell wants to break the back of the Fed put, and if you want to do that you hide behind unemployment, the most lagging indicators, before you can get pushed off of the ledge to acknowledge that we might actually be at a point where monetary policy should not be as restrictive,” she said.

“He’s an extremely astute, savvy, shrewd former private equity investor. He knows he’s following and citing lagging data and yet here we are.”

Powell also cheered the return to Earth of a once soaring housing market. “He welcomes the deflation of this housing bubble. He knows that investors swarming the market has been very detrimental to the plight of middle income earners,” said DiMartino Booth. “He embraces with open arms the prospect of any speculative aspect exiting the housing market.”

SCROOGE

Powell emphasized the need for a tight labor market, with a 3.7% jobless rate still near historic lows, to soften before the Fed could be convinced to let up on its tightening campaign.

“There’s the feel that when the unemployment rate does increase, it’s going to snap up and there’ll be an unemployment rate shock,” DiMartino Booth said. “If we were to get past the 4.4% that they presume year-end 2023, I think you’d have to see something of that magnitude for them to back off.”

That’s why Powell wanted to convey to markets that not only will the Fed keeping tightening the monetary screws this year, it may keep doing so well into 2023.

“The market thought this party was over at least in November if not December. Who wants to be Scrooge? And yet the door was open yesterday to continued tightening if this inflation continues on into 2023."