Fed Indicates Rate Hikes Will Continue

The Federal Reserve Open Market Committee (FOMC) raised the target for the federal funds rate by 0.5% at its interest rate decision Dec. 14 to a range of 4.25%-to-4.50%, following four consecutive 0.75% rate hikes. The FOMC noted “ongoing increases” in interest rates will be necessary to reach its inflation objective. The FOMC judged spending and production to be growing at a “modest” pace at present, with the labor market deemed to be very tight and inflation “elevated.”

The Summary of Economic Projections (SEP a.k.a. the Dot Plot) showed the FOMC expects to raise the policy rate to between 5.00% and 5.25% by year-end of 2023, above market expectations for the fed funds rate to be below the 5% mark by that time. In the press conference following the interest rate decision, Chair Powell noted 17 of the 19 members of the FOMC penciled in feds fund rate above 5% at the end of 2023, indicating broad-based support for sustained higher rates.

By year-end 2024, the FOMC projected the fed funds rate to decline to 4.1%, indicating rate cuts are likely only in 2024. The FOMC projects for the economy to grow modestly next year, with real GDP forecast to rise an anemic 0.5% in the fourth quarter of next year over the same quarter of this year. Economic growth is forecasted to return to trend growth rate of 1.8% only in 2025. The FOMC’s unemployment rate forecast has been revised higher for 2023 from 4.4% to 4.6% and is expected to remain around that level through 2025. The Fed’s inflation projections for year-end 2023 were revised higher from 3.1% to 3.5%. Inflation forecasts for 2024 and 2025 were also revised higher to 2.5% and 2.1%, respectively, indicating the Fed sees major obstacles to its goal of reducing inflation.

The Consumer Price Index (CPI) rose by 0.1% last month and by 7.1% from a year-ago. Both were below consensus forecasts for 0.3% and 7.3% increases in monthly and yearly terms, respectively. Core inflation rose by 0.2% and 6.0% on monthly and annual bases, respectively, also below consensus forecasts for 0.3% and 6.3% respective gains. There were many positives in the report: core CPI rose at the slowest pace since September 2021; core goods prices declined outright for the second consecutive month; and more CPI components saw price increases slow.

On the flip side, shelter, which accounts for roughly a third of the index, rose again sharply by 0.6% last month, pushing annual shelter inflation to 7.1%. Prices of core services, which are “stickier,” continue to rise at elevated rates. Shelter and core service price increases are likely to keep inflation high for some time.

Bill Adams is senior vice president and chief economist at Comerica. Waran Bhatruethan is vice president and senior economist at Comerica.