By J.G. Collins
The decision came a day after the Federal Reserve Bank of Atlanta dropped its much-watched estimate of third-quarter 2022 GDP (“GDP Now“) to just 0.3 percent on Sept. 20, after residential fixed investment disappointed, printing at -1.28 percent, when the Atlanta Fed had anticipated it to print at +0.3 percent. (Move the cursor over each bar, here, to see the interplay of the “GDP Now” elements.)
The 75 basis-point interest rate increase was largely priced into the market, and most observers expected it. Some anticipated—and feared—a 100 basis-point hike, or 1 percent. Nevertheless, the market responded negatively to the rate hike, and the Dow Jones Industrials Average fell by 1.7 percent. The benchmark S&P 500 Index fell the same percentage amount.
It appears that what troubled the market was the Fed’s disappointing so-called “dot plots,” formally the “Summary of Economic Projections,” also released on Sept. 21, which is prepared by members of the Federal Open Market Committee, the Fed’s policy-making arm, and their staffs.
The dot plots are basically prognostications as to the future direction of the economy at year-end in the current and three future years and for the longer term, analyzing gross domestic product (GDP), unemployment, inflation, and interest rates.
None of the projections are good. As seen in the rightmost set of columns, the range of GDP went from negative 0.3 percent in 2023 to 2.6 percent 2024. What’s called the “central tendency,” where most of the estimates tend to be (the three highest and the three lowest are thrown out)—and the best estimate, in my view—showed GDP growth of no more than 2 percent.
I cannot help but think that even the central tendency range of estimates are sanguine. I suspect that inflation will have a longer tail than the 2023/2024 declines that the central tendency would indicate. I expect that a federal funds rate, the rate the Fed charges member banks, will need to be in the range of 5–6 percent to ramp down the rate of inflation, especially if job strength (which we attribute mostly to a low labor participation rate) continues. (The 5–6 percent we think necessary is the rate to keep inflation stable at the Fed’s preferred 2 percent rate; it’s what Fed watchers call the “terminal rate.”)
The other aspect of bringing down inflation is reducing the Fed’s balance sheet. While the Fed has increased the “burn-off” of Fed assets to $95 billion this month, we have long felt that amount was insufficient. The assets—comprised of Treasuries and mortgage-backed securities (MBS)—can be sold instead of “burned off.” Fed Chair Jerome Powell did not rule out the possibility, at least for MBS, but not at this time, he said. Selling off the MBS would reduce the balance of cash in the economy, which creates some liquidity risk, but also reduces inflation.
One aspect of the continuing rate hikes will be that the U.S. dollar will continue to dominate the currency markets. For multinationals, that will cause reduced earnings from overseas as the earnings are translated. As we wrote earlier this week, companies like Federal Express will suffer these kinds of translation losses as well as margin pressure.
We revise our GDP estimate for this quarter to -0.5 percent.
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