The Fed just predicted a pretty lousy economy - and the markets took notice

The Fed just predicted a pretty lousy economy – and the markets took notice

Comment

The Federal Reserve (Fed) announced on September 21 that it had raised interest rates by 75 basis points (bps), or three-quarters of a percentage point.

The decision came a day after the Federal Reserve Bank of Atlanta lowered its much-watched estimate of third-quarter 2022 GDP (“GDP Now”) to just 0.3% on September 20, after residential fixed investment disappointed, printing at -1.28%, when the Atlanta Fed had expected it to print at +0.3%. (Move the cursor over each bar, here, to see the interaction of the “GDP Now” elements.)

(Components of “GDP Now” release date for Q3 2022 GDP)

The 75 basis point interest rate hike was widely priced into the market, and most observers expected it. Some were anticipating – and fearing – a 100 basis point or 1% hike. Nonetheless, the market reacted negatively to the rate hike and the Dow Jones Industrials Average fell 1.7%. The benchmark S&P 500 index fell by the same percentage.

It seems what has troubled the market is the Fed’s disappointing so-called ‘dot plots’, officially the ‘Summary of Economic Projections’, also released on September 21, which is prepared by members of the Federal Open Market Committee, Fed policy. -make the arm, and their staffs.

Dot charts are essentially predictions as to the future direction of the economy at year-end in the current year and the next three years and longer term, by analyzing Gross Domestic Product (GDP ), unemployment, inflation and interest rates.

Epoch Times Photo
(Summary of Federal Reserve projections)

Comments

None of the projections are good. As seen in the rightmost set of columns, the range of GDP has increased from minus 0.3% in 2023 to 2.6% in 2024. This is called the “central tendency”, where the most estimates tend to be (top three and bottom three discarded) – and the best estimate, in my opinion – showed GDP growth of no more than 2%.

I can’t help but think that even the central tendency range of the estimates is optimistic. I suspect inflation will have a longer tail than the 2023/2024 dips that the central trend would indicate. I expect that a federal funds rate, the rate the Fed charges member banks, will need to be in the 5-6% range to bring the inflation rate down, especially if the strength of employment (which we attribute mainly to a low labor force participation rate) continues. (The 5-6% we think is needed is the rate to hold inflation steady at the Fed’s preferred rate of 2%; it’s what Fed watchers call the “terminal rate.”)

The other aspect of reducing inflation is reducing the Fed’s balance sheet. While the Fed increased the burn-off of Fed assets to $95 billion this month, we have long felt that this amount was insufficient. The assets – made up of treasury bills and mortgage-backed securities (MBS) – can be sold instead of “burned”. Fed Chairman Jerome Powell has not ruled out the possibility, at least for MBS, but not at this time, he said. Selling the MBS would reduce the cash balance in the economy, which creates some liquidity risk, but also reduces inflation.

One aspect of continued rate hikes will be that the US dollar will continue to dominate currency markets. For multinationals, this will lead to a reduction in income from overseas as income is converted. As we wrote about earlier this week, companies like Federal Express will experience these kinds of translation losses as well as margin pressure.

We are revising our GDP estimate for this quarter to -0.5%.

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Disclosure: The opinions expressed, including the outcome of future events, are the opinions of the company and its management only as of September 21, 2022, and will not be revised for events after this material is submitted to Epoch editors. Times for publication. The statements contained herein do not represent and should not be considered as investment advice. You should not use this article for this purpose. This article includes forward-looking statements about future events that may or may not develop in the author’s opinion. Before making any investment decision, you should consult your own investment, business, legal, tax and financial advisers. We partner with the directors of Technometrica on investigative work in certain elements of our business.

We do not have a stock, option or similar derivative position in any of the companies mentioned, and do not intend to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I receive no compensation for this (other than from The Epoch Times as a business columnist). I have no business relationship with any company whose stock is mentioned in this article.

J. G. Collins

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JG Collins is Managing Director of Stuyvesant Square Consultancy, a strategy consulting, market research and advisory firm in New York. His writings on economics, business, politics and public policy have appeared in Forbes, the New York Post, Crain’s New York Business, The Hill, The American Conservative and other publications.

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