Fed’s half-point hike signals possible ‘soft landing’ for some

By Doug Bailey

Hopes that the U.S. Central Bank could navigate an economic “soft landing” in the face of inflation headwinds and gathering recession clouds were raised a bit as prices began softening and interest rate hikes were eased.

Federal Reserve officials on Wednesday ended the most inflationary period in nearly 40 years with yet another rate increase, which, at 50 basis points, was a more modest change compared to its previous four consecutive 75-basis-point hikes, and presented a mildly optimistic outlook for the coming year in which the inflation tiger might be tamed, though not fully restrained..

At the same time, Fed officials said they weren’t done raising rates, signaling the landing cushion isn’t as soft as they’d like and said borrowing costs will likely need to go painfully higher than previously anticipated next year to stay ahead of inflationary pressures.

Rate may climb to 5.1 percent

Wednesday’s announcement pushed the federal fund target rate to 4.1 percent and indicated the rate may climb to 5.1 percent by the end of 2023, signaling another three-quarters worth of adjustments in the coming year.

“The Fed’s policy of increasing interest rates, coupled with reducing its balance sheet, produced the desired effect of having inflation peak and getting it on a downward glide path,” said Dr. Ryan Lemand, non-executive director at FundRock Middle East (an Apex Group subsidiary). “We expect at least two more hikes of 25 basis points each. More importantly, we expect the Fed to continue reducing its balance sheet, beyond the $400 billion that took place in recent months, which has the most downward effect on risky assets, whose rise has been loosening financial conditions, contrary to the Fed’s current policy of tightening them.”

Fed officials expect the unemployment rate to rise to 4.6 percent by the end of next year, a slightly bigger number than was previously forecast, and that it will stay at that level at least through 2025.

But the median inflation rate estimate is 2.8 percent next year, and then for the economy to finally reach the Fed’s target of 2 percent in 2025.

Steve Rick, chief economist at CUNA Mutual Group said perhaps the biggest impact of the Fed’s moves will be on housing.

Mortgage rates 'will remain elevated"

“Americans are concerned home prices are overvalued and creating another housing bubble,” he said. “We’ve seen the home price to home income ratio rise from a historically average around 3 to 3.5 times the median annual income to the current 4.6 times. Although this seems high, as the Fed continues to tighten monetary policy, mortgage rates will remain elevated, discouraging potential buyers and ultimately making the housing market less competitive.”

Higher rates have been painful to consumers, Rick said, but he remained hopeful prices will stabilize and another housing bubble will be avoided.

Meanwhile the Fed’s actions did nothing to quell the debate over recession: whether the country is in one or headed toward one, and how extreme it will be.

"The needed tightening of financial conditions will contribute to a material slowdown in Real Gross Domestic Product to 0.1% in 2023, with a recession likely over the next 12 months,” said Thomas Holzheu, chief economist at Swiss Re America. “But the potential for a soft landing has improved recently.”

Holzheu said while a typical recession sees the Federal Reserve cut interest rates to stimulate the economy, this cycle will be different.

“Given inflation will remain well above 2% over the course of next year, we don't expect the Fed to begin cutting interest rates until Q1 2024, resulting in an economic recovery that is weaker than prior episodes,” he said. “We see 10-year Treasury yields at 3.6% through the end of 2023."

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].