Expect higher interest rates for longer, Fed data suggests

Jerome Powell says a soft landing is not a 'baseline', pointing to external factors

Federal Reserve Chairman Jerome Powell. Reuters
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Federal Reserve Chairman Jerome Powell said the central bank is almost done raising US interest rates, but new projections from the central bank suggest that rates are likely to be held higher for a prolonged period of time.

Rates were left unchanged on Wednesday – the second pause in three meetings – as Mr Powell believes the Fed can now “proceed carefully” in future rate decisions.

“I think we have come very far, very fast,” he told reporters. He added that the risks become more “two-sided” as the Fed nears what it believes to be the appropriate restrictive level.

In its updated quarterly projections, a majority of Fed participants expect one more rate increase this year that would bring the federal funds rate to 5.6 per cent.

But fewer rate cuts are expected next year as the economy shows resilience. The federal funds rate is forecast to fall to 5.1 per cent by end of 2024, up from June's estimation of 4.6 per cent.

Mr Powell maintained the Fed's hawkish stance.

“We are prepared to raise rates further if appropriate and we intend to hold policy at a restrictive level until we're confident that inflation is moving down sustainability towards our objective,” Mr Powell said.

The Fed has raised interest rates to the target range of 5.25 per cent to 5.50 per cent since March 2022 as part of its campaign to bring inflation back down to its 2 per cent target.

The US economy has remained strong in the face of the Fed's rate increases. New economic forecasts seem to reinforce that, with Fed officials projecting economic growth to climb 2.1 per cent this year, as opposed to their earlier projection of 1.0 per cent.

Consumer spending and wage growth remain strong. The labour market has also shown signs of cooling, although jobs are still being added at a steady pace and unemployment remains near a historic low.

Fed officials project their preferred inflation metric to fall to 2.5 per cent by the end of next year before climbing back down to the central bank's 2 per cent goal by 2026. The funds rate is forecast to drop below 3 per cent in 2026 as well.

A soft landing appears to be the most likely outcome, but Mr Powell exercised caution, telling reporters that a soft landing was not a baseline expectation.

External factors such as rising oil prices, resumption of student loan payments, the car workers' strike and the looming threat of a government shutdown could complicate the Fed's plan.

“Ultimately, this may be decided by factors that are outside our control,” Mr Powell said.

“But I do think it's possible. And I also think this is why we are positioned to move carefully.”

Traders expect interest rates will remain unchanged this year before dipping to 4.50 per cent and 4.75 per cent by the end of 2024, data from the CME Group showed.

Updated: September 21, 2023, 3:29 PM