Fed: Main implications for rate hike decision

As expected, the Fed raised the main interest rate by 75 basis points. Expectations regarding the degree of monetary policy tightness for the future show that the Fed has adopted a rather hawkish tone and will carry its proactiveness in raising interest rates to future meetings. This means that higher interest rates and tighter-than-normal conditions will hold for a little longer.

If we look at the highlights from the Fed statement;

·        While the Fed increased the benchmark rate by 75 basis points to the range of 3%-3.25% in line with the expectations, new estimates from the authorities show a median forecast of 4.4% at the end of 2022 and 4.6% at the end of 2023.

·        Although the decision was unanimous, the dot chart points to a 10-9 majority in favor of the march above 4.25% this year, showing that a fourth consecutive 75 basis point increase is possible in November. This means that multiple dose rate hikes are deemed appropriate.

·        Policy makers expect rates to decrease to around 3.9% in 2024 and to 2.9% in 2025. Even so, it means that high interest rates will remain in place.

·        The long-term balance interest rate, on the other hand, did not change and was left as 2.5%.

·        Statement nearly identical to previous FOMC meeting in July; While the Fed said the latest indicators point to “moderate growth” in spending and production, it said data “softened” in July.

·        GDP growth projections were revised down to 1.2% in 2023 and 1.7% in 2024, remaining below the long-term trend. Unemployment is expected to rise to 4.4% in 2023.

Economic projections of Fed Board members and Fed chairmen, under their individual assumptions of appropriate monetary policy, September 2022… Source: Federal Reserve

It is seen that the Fed reflects the slowdown in growth in its reservations about the economy to the projections by calculating the current conditions and the effects of monetary policy tightening. Accordingly, expectations for real GDP growth are noticeably lower in our current horizon compared to the previous forecast period. This includes both the slowdown of the economy in the face of cyclical threats, as well as the slowdown effect of rate hikes, resulting in less spending, more expensive credit use. This picture is understandable when we compare it to the expectations of slower growth and higher federal funding rate for the respective years.

The same is true for the unemployment rate expectations, which have been revised upwards. The Fed’s expectations reflect the forecast that the labor market will slow down and even lose some jobs in this economic cycle. While the unemployment rate continues to be seen as 4% in the long term, the trend of adding less jobs while reducing inflation may be valid in the forecast horizon that continues towards 2025. As a matter of fact, the level in the 2025 projection made for the first time is higher than the 2024 level predicted in the June FOMC.

As a result, the Fed assesses the impact of further economic weakening in the future and acknowledges that it is included in the scenario in monetary policy progress. When we look at the implied interest rate expectations in this period, it is understood that the Fed considers it appropriate to advance a monetary policy with restrictive effects. Although the Fed’s real hawkishness has been taking place since August, the main determinant of this is inflation surprises, the structural details of which include variables much different from energy. Now, within the framework of numerical expectations and action, the Fed has extended this hawkish horizon to a wider time. Powell will certainly soften this stance once he sees bearish signs in inflation, but proactivity is currently seen as more beneficial than a no-action stance.

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