The U.S. Federal Reserve delivered a third consecutive three-quarter-point hike in an aggressive move to bring down inflation, and signaled further large increases at upcoming meetings. Anthony Okolie speaks with James Marple, Senior Economist, TD Bank, about the outlook for the U.S. economy.
- Well, looking at the statement, they changed very, very little. A couple of words at the very beginning reflecting current economic conditions, just updating for-- these things have now happened. But they changed nothing else in the statement.
75 basis points in hikes, broadly expected. I think everyone on the Street markets had been expecting that kind of rate hike. What was a little more surprising was their accompanying survey of economic projections, where they survey all the members of the FOMC, both those that are voting and those that aren't. And there you saw a real upward migration in where they anticipate the Federal funds rate going from now.
So, as you said, they brought that up to 4.4%, and they see even more hikes over the course of the next year. So that's the big change. They also brought down their economic projections quite a bit. I mean, marking to the data we've seen already this year, they have virtually no economic growth over the course of 2022. Of course, we had those first two quarters where growth was actually negative, so that makes some sense. But then again, weakening the rate of growth next year by an almost equal amount and having below-trend economic growth continue through next year.
And just as important, they now have a real, notable upward migration in the unemployment rate. So they had previously had that under 4%, which is sort of where they see it over the long term. They now have it getting to 4.4% and staying there in 2023 and 2024. So they're clearly saying we're going to have to see some economic pain in order to bring inflation down. And just on the inflation front, they also upwardly revised their inflation forecast and expect it to take a bit longer to get back to their 2% target.
- And you referred to the fact that, look, we're going to have to hike interest rates, and that economic growth, there's going to be some pain because of that. I want to go back to another point you mentioned. The FOMC does expect to see a Fed funds median rate of about 4.4% by the end of the year. Where do you see rates going from here?
- Well, probably still higher. So we're at 3.25%. There's probably more hikes to come. We think they'll get at least to 4% by the end of this year. And of course, we'll have to watch the economic data if we continue to see inflation surprises it has.
That's job number one. That's what they're solely focused on. And so that's what-- we'd probably see rates have to go even higher. If they get any luck on the inflation front, maybe a little bit like we saw in Canada, where inflation is surprising a little bit lower and coming down, making one step in the right direction, maybe they don't have to hike as much. But the Fed Chair was pretty consistent on that, that they're watching measures of inflation, and they really want to be convinced that they don't make the mistake of calling even the decline temporary as they did the increase.
- And as you mentioned, they want to see core inflation moving down, certainly. I want to get to the markets. How have bond markets reacted to his comments? Because certainly we've seen particularly the two-year treasury, its yield has gone up-- I think it touched above 4%. What's been the reaction by the bond market so far?
- Yeah, well, on the statement, everything jumped, especially at the short end of the curve. And then, as the dulcet tones of Jay Powell started alleviating some of those concerns we saw, we've seen bond yields come back in a little bit. But just looking at the curve, we've seen yields in general up, and obviously more at the short end as markets are starting to, I think, believe the Fed when they say they're solely focused on inflation.
And perhaps the signaling that even some upward migration and unemployment wouldn't be enough to change their hand, that's coming through in expectations for higher short-term rates.
- Now, of course, there are certain risks to their outlook in inflation. We've got the Russia-Ukraine conflict. But what do you think are the other bigger risks to their path on interest rates going forward?
JAMES MARPLE: Well, certainly, you've seen the effect of interest rates on interest rate-sensitive sectors of the economy, especially in the housing market. We've had another decline in existing home sales. We've seen car sales and anything interest rate related that have been weak. And so I think they'll be looking at that.
They're going to be looking at broad indicators of economic activity, especially the consumer side of things. Consumer spending has been quite weak. But I mean, again, I think they're going to be looking at inflation.
In terms of the economic risks, I mean, any kind of major financial shock might cause them to react a little more slowly. But I think, really, it's going to hinge on inflation. They're going to be willing to, again, tolerate some economic deterioration in the service of getting to their 2% goal.
ANTHONY OKOLIE: Yeah, and Jay Powell certainly reiterated that they want to get down to that 2% target. Finally, the US dollar has been on a tear recently. And the dollar index just hit a new 20-year high against a basket of currencies. Where do you see the US dollar going from here?
JAMES MARPLE: Well, I think if we see some of the-- so I think a lot about the Canadian dollar versus the US dollar. So in that cross, the Canadian economy, at least up to date, looks like it's been outperforming. Now, I think there are some doubts about whether that can be maintained. But if we were to see some of that continued resilience in the Canadian economy, we might get a little higher Canadian dollar versus the US, which has been hit really hard.
Of course, I think the inflation differentials will matter because as much as we've started to see inflation come down a little bit in Canada, and then that hurt the loonie because rate hikes for the Bank of Canada aren't expected to be as severe. So I would say that I think we'll probably see a little more strength in the Canadian dollar over the next little while. I mean, it's weakened a whole lot, and I don't think that monetary policy in the two countries will be all that different. And both very much committed to bringing inflation to 2%.
Against the euro, I think we're in for some continued weakness. I'm not sure it'll get much-- the euro will get much weaker from where it is today, but certainly their challenges are long standing in terms of energy. And they're going to have a hard time just given they're going into recession, likely by the end of this year, to tighten policy nearly as much as we're seeing on this side of the Atlantic.
ANTHONY OKOLIE: Still a lot of moving pieces, James. Thanks very much for your insights.
- You're welcome.