Faster Growth and Cooler Inflation Set Stage for Updated Forecasts from Federal Reserve Officials

Introduction

Faster growth, cooler inflation, and a job market that won’t quit have set the stage for an updated batch of forecasts from Federal Reserve officials next week. These forecasts are likely to reflect their growing faith in prospects for an economic soft-landing. However, one thing that is unlikely to change is keeping one more rate hike on the table.

Signaling and Risk Management

“A lot of it is signaling, and risk management,” says Deutsche Bank economist Matthew Luzzetti. Most economists believe that the U.S. central bank will leave short-term interest rates in the current 5.25%-5.50% range at the close of its Sept. 19-20 meeting. The main unknown is how policymakers reshape their stale forecasts from three months back.

Rip Up the Outlooks

Economic data since the June 13-14 meeting has persistently surprised to the upside, meaning Fed officials will need to rip up those outlooks that saw moribund growth, rising unemployment, and only modest improvement in inflation.

Not Ready to Say So

Given the rosier picture, Luzzetti believes that Fed policymakers probably won’t lift the policy rate any further. However, they are not ready to say so. If they declare the cycle done from a tightening perspective, it could lead to a significant easing of financial conditions, which is not what they want to deliver.

Maintaining Flexibility

Luzzetti believes it’s critical for the Fed to maintain flexibility and optionality. For him and many other analysts, this means a majority of Fed policymakers will probably still pencil in a year-end policy rate of 5.6%, one quarter point above where it is now.

Minority View

SGH Macro Advisors’ Tim Duy is among the minority of economists who believe economic circumstances will force the Fed to raise rates again later this year. He also expects policymakers to signal rates will stay higher for longer, with just two rate cuts next year compared to the four anticipated in the Fed’s June summary of economic projections.

Projections and Forecasts

The Fed’s seven governors and 12 Fed bank presidents will share their projections with one another next week as part of their policy deliberations. These projections will be published at the close of their two-day meeting on Wednesday.

Upgraded Forecasts

Economists believe that policymaker GDP forecasts for this year will get a substantial upgrade. Despite the interest-rate hikes over the last 18 months, the U.S. economy expanded at about a 2% pace in the first half of this year and may be growing even faster in the current quarter.

Optimism on the Labor Market

Economists also expect Fed policymakers to express more optimism on the labor market. The unemployment rate leapt to 3.8% in August, its highest since before the Fed began raising rates. However, the increase was due to more people looking for work rather than losing their jobs, which is seen as a mark of strength.

Lower Inflation Expectations

Economists also see policymakers projecting lower inflation this year than they expected in June. Inflation as measured by the personal consumption expenditures price index peaked at 7% last summer before falling rapidly this year. However, if progress towards the Fed’s 2% goal slows next year, it may mean fewer interest rate cuts.

Conclusion

The updated forecasts from Federal Reserve officials next week are expected to reflect their growing faith in prospects for an economic soft-landing. While most economists believe that short-term interest rates will remain unchanged, the main unknown is how policymakers will reshape their forecasts based on the recent positive economic data.