The U.S. Federal Reserve raised its benchmark rate a half-point to the highest level since 2008, and signaled rates would not be coming down anytime soon. Anthony Okolie speaks with James Marple, Senior Economist, TD Bank, about the outlook for the U.S. economy.
Print Transcript
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As expected, the Fed hiked interest rates another 50 basis points to the highest rate in 15 years. But they also signaled more rate hikes to come. James, did anything surprise you today?
Well, perhaps what was surprising was how little changed in the statement. They absolutely kept it exactly the same as before, only changing two words, and those were very minor. They did raise by 50 basis points, which is a step down from the 75 basis points we saw in the previous three meetings. That was largely anticipated and telegraphed by the Fed previously. But really, I think there was more surprises or a little more information in their survey of economic projections, which comes once a quarter.
So let's get to that, because certainly, there have been some changes to the economic projections as you've stated. Let's start with economic growth. What are you seeing there?
Sure. Well, they brought down their expectations for GDP growth over the next year from 1.2% all the way down to 0.5%. So that's pretty close to stall speed. And with a growth over the course of the year of 0.5%, that makes it somewhat likely that you could even get a negative quarter or two. So they're very close to the line between recession and expansion and really seeing very little in the way of economic growth as a consequence of their actions.
And you could see it in other economic data as well. They raised a little bit their expectations for the unemployment rate, not as much as they reduced GDP growth. But they now have almost a percentage point increase in unemployment, so coming from 3.7% all the way up to 4.6%. And, of course, it's been stated that every time there has been an increase in unemployment of that amount, it has been in a recession. It kind of-- it goes up. Once it starts going up, it doesn't stop. It keeps going.
So there's that. And then on inflation, they also raised their expectations for inflation, which is, I think, again, really, the cause of some of the downward revisions to unemployment is they're seeing inflation with a little more staying power. And as a result, they think they will have to lift rates higher. So on their expectations for the policy rate, they brought that above 5% to this range between 5% and 5.25%.
The important point there is that's a year-end target for 2023. So they see, at the end of next year, the rate at 5.25%. And we've seen many analysts and even futures markets that are pricing rate hikes-- or sorry, rate cuts, pardon me, by the end of next year. And I think they're trying to say that with those projections that they intend to stay the course in terms of leaving rates at least through the end of next year at an elevated level.
And that's interesting because certainly there's a discrepancy with what the Fed is saying and what markets-- how markets are forecasting that. Now, I want to touch a little bit about that. Let's talk about bond market's reaction to the news and what our yield curve's currently telling investors about the economy and as you mentioned, the potential for recession next year.
Sure. Well, we did see the two-year rate really move higher on the news, which is not surprising. I mean, they're signaling higher rates for a longer period into next year. And we saw the longer end of the curve, though, not move nearly as much. And so you see this increased inversion in the yield curve with shorter-term rates higher than longer-term rates.
In some sense, they validated that with their own projections, which see the Fed funds rate decreasing but not until 2024 but going down by 100 basis points in 2024 and then another 100 basis points in 2025. And if you think of the long-term of the bond market as reflecting those expectations for eventual cuts, some of that makes sense.
But certainly, the size of the inversion right now between short- and long-term rates is something that we have seen in the run-up to recession. And when the Fed has tightened by over 400 basis points, perhaps, again, that's not that surprising. But certainly, you're getting the warning signals in the yield curve that economic growth is going to slow over the next year.
And potentially, a soft landing might not be the scenario that we see next year.
Sure
What are the potential risks do you see to the Fed's outlook going forward?
Well, I think a lot of it will hinge on inflation. And we had, fortunately, some good news on the inflation front, where inflation came down a little bit more than expected. And the monthly run rate, not just the year-on-year rate, but the monthly run rate was right around their target. And, of course, that reflected some decline in energy prices, which is volatile.
But if they get luck on inflation, if inflation continues to slow, you know, we've seen all these months of it. It's surprising on the upside. If that turned the other direction, that would be what allows the soft landing scenario to play out and what allows maybe them not to have to hike as much as they anticipate. On the other hand, if inflation is more sticky, you know, I think that goes in the other direction.
We have already seen really interest-rate sensitive sectors of the economy start to slow, but we haven't really seen that show up in the labor market. So again, I think that's the other thing that they'll be looking for very closely and where some of the risks are, as we mentioned, on the unemployment rate. Once it starts to go up, it doesn't usually stop at 1%. So if it starts going a little bit higher than that, and there's a hard landing, again, that may change the course of policy.
OK. Now, let's move on to the US dollar because certainly, given this sort of more hawkish tone by the Fed, will that add more fuel to the US dollar, which has been very strong this year? What's your outlook on the US dollar going forward?
Sure. Well, I think over the next little while it will probably strengthen a bit against the euro against the Canadian dollar. That just reflects this interest-rate divergence, and, you know, a hawkish Fed is certainly validating some of that expectation.
So I don't know over the course of a longer period, 18 months, we probably will see a little bit of recovery in some of these currencies. But certainly, over the next little while when the Fed is so much in tightening mode and we're seeing some statements of-- more statements toward pause or slowing in the pace of rate hikes elsewhere, that's going to be strong for the dollar. [THEME MUSIC]
As expected, the Fed hiked interest rates another 50 basis points to the highest rate in 15 years. But they also signaled more rate hikes to come. James, did anything surprise you today?
Well, perhaps what was surprising was how little changed in the statement. They absolutely kept it exactly the same as before, only changing two words, and those were very minor. They did raise by 50 basis points, which is a step down from the 75 basis points we saw in the previous three meetings. That was largely anticipated and telegraphed by the Fed previously. But really, I think there was more surprises or a little more information in their survey of economic projections, which comes once a quarter.
So let's get to that, because certainly, there have been some changes to the economic projections as you've stated. Let's start with economic growth. What are you seeing there?
Sure. Well, they brought down their expectations for GDP growth over the next year from 1.2% all the way down to 0.5%. So that's pretty close to stall speed. And with a growth over the course of the year of 0.5%, that makes it somewhat likely that you could even get a negative quarter or two. So they're very close to the line between recession and expansion and really seeing very little in the way of economic growth as a consequence of their actions.
And you could see it in other economic data as well. They raised a little bit their expectations for the unemployment rate, not as much as they reduced GDP growth. But they now have almost a percentage point increase in unemployment, so coming from 3.7% all the way up to 4.6%. And, of course, it's been stated that every time there has been an increase in unemployment of that amount, it has been in a recession. It kind of-- it goes up. Once it starts going up, it doesn't stop. It keeps going.
So there's that. And then on inflation, they also raised their expectations for inflation, which is, I think, again, really, the cause of some of the downward revisions to unemployment is they're seeing inflation with a little more staying power. And as a result, they think they will have to lift rates higher. So on their expectations for the policy rate, they brought that above 5% to this range between 5% and 5.25%.
The important point there is that's a year-end target for 2023. So they see, at the end of next year, the rate at 5.25%. And we've seen many analysts and even futures markets that are pricing rate hikes-- or sorry, rate cuts, pardon me, by the end of next year. And I think they're trying to say that with those projections that they intend to stay the course in terms of leaving rates at least through the end of next year at an elevated level.
And that's interesting because certainly there's a discrepancy with what the Fed is saying and what markets-- how markets are forecasting that. Now, I want to touch a little bit about that. Let's talk about bond market's reaction to the news and what our yield curve's currently telling investors about the economy and as you mentioned, the potential for recession next year.
Sure. Well, we did see the two-year rate really move higher on the news, which is not surprising. I mean, they're signaling higher rates for a longer period into next year. And we saw the longer end of the curve, though, not move nearly as much. And so you see this increased inversion in the yield curve with shorter-term rates higher than longer-term rates.
In some sense, they validated that with their own projections, which see the Fed funds rate decreasing but not until 2024 but going down by 100 basis points in 2024 and then another 100 basis points in 2025. And if you think of the long-term of the bond market as reflecting those expectations for eventual cuts, some of that makes sense.
But certainly, the size of the inversion right now between short- and long-term rates is something that we have seen in the run-up to recession. And when the Fed has tightened by over 400 basis points, perhaps, again, that's not that surprising. But certainly, you're getting the warning signals in the yield curve that economic growth is going to slow over the next year.
And potentially, a soft landing might not be the scenario that we see next year.
Sure
What are the potential risks do you see to the Fed's outlook going forward?
Well, I think a lot of it will hinge on inflation. And we had, fortunately, some good news on the inflation front, where inflation came down a little bit more than expected. And the monthly run rate, not just the year-on-year rate, but the monthly run rate was right around their target. And, of course, that reflected some decline in energy prices, which is volatile.
But if they get luck on inflation, if inflation continues to slow, you know, we've seen all these months of it. It's surprising on the upside. If that turned the other direction, that would be what allows the soft landing scenario to play out and what allows maybe them not to have to hike as much as they anticipate. On the other hand, if inflation is more sticky, you know, I think that goes in the other direction.
We have already seen really interest-rate sensitive sectors of the economy start to slow, but we haven't really seen that show up in the labor market. So again, I think that's the other thing that they'll be looking for very closely and where some of the risks are, as we mentioned, on the unemployment rate. Once it starts to go up, it doesn't usually stop at 1%. So if it starts going a little bit higher than that, and there's a hard landing, again, that may change the course of policy.
OK. Now, let's move on to the US dollar because certainly, given this sort of more hawkish tone by the Fed, will that add more fuel to the US dollar, which has been very strong this year? What's your outlook on the US dollar going forward?
Sure. Well, I think over the next little while it will probably strengthen a bit against the euro against the Canadian dollar. That just reflects this interest-rate divergence, and, you know, a hawkish Fed is certainly validating some of that expectation.
So I don't know over the course of a longer period, 18 months, we probably will see a little bit of recovery in some of these currencies. But certainly, over the next little while when the Fed is so much in tightening mode and we're seeing some statements of-- more statements toward pause or slowing in the pace of rate hikes elsewhere, that's going to be strong for the dollar. [THEME MUSIC]