The Federal Reserve raised its benchmark interest rate for the first time since 2018, but it’s already time for the market to look past this well-telegraphed move, according to Kathy Bostjancic, chief U.S. economist at Oxford Economics.
While there are complicating factors such as the war in Ukraine, the most prominent issue for the Fed is that economic growth remains quite strong. If the Fed is shy about raising rates and reducing the balance sheet because of war, there is a risk that it gets even further behind on inflation, Bostjancic says. Consumers are still sitting on a high level of savings and benefitting from rising wages, and if the Fed gets further behind the curve on inflation by waiting, it will only increase the risk of the central bank becoming more hawkish later on.
The Fed forecast six more rate hikes and tellingly, its view of inflation’s trajectory moved up considerably, with a forecast now above 4% this year.
There are risks on both sides of the Fed equation. If it is too hawkish and tightens too quickly, that can send the financial markets into a convulsion and lead to a mass selling of risk assets which feeds back into the real economy. Recent action in the bond market showing a narrowing of the spread between the two-year and 10-year treasuries stoked fears of an inverted yield curve, which is a signal that this worst-case, recessionary scenario could play out.
After the Fed announcement on Wednesday, yields rose to their highest levels since 2019.
Recession is not the base case for Bostjancic, even if she says the Fed won’t be blind to these signals.
Fed Chair Jerome Powell indicated during recent testimony that he sees inflation running a little faster than the Fed’s previous expectation, and any adjustment from the Fed is significant, Bostjancic said. Her view of the inflation outlook into the meeting was much higher than the median forecast of 2.7% year over year through Q4 2022 — closer to 4% than 3%, and that has now been matched by the…