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October 2022

The Fed: Paul Single Q3 2022

Key Points

  • The Fed has moved to a very hawkish stance against inflation
  • The Fed is willing to allow weaker economic growth in order to reduce inflationary pressures
  • The Fed is committed to returning inflation to the target rate of 2.0%

Since the end of last year, the Fed’s view on the economy has evolved. Despite the significant slowing in the pace of economic growth, there has not been much of a change in the unemployment rate.

And despite the central bank raising the overnight Fed Funds rate from the near-zero level back in March to today’s 3.875% (with plans to raise it further), inflationary pressures have continued to increase (see chart 1).

At its recent meeting in early-November, the Fed made a very hawkish move. It barreled ahead with a fourth rate hike of 75 bps. Its plan in the future appears to slow the size of future hikes, but the Fed is hinting that it may end up with a higher terminal rate than previously thought, which was 4.6%. The reason for the slowing pace of future hikes is to buy time to see what economic impact the hike has on the economy, and the economic impact tends to be delayed.

The Fed continues to believe it will be able to arrange a soft landing for the economy. But it will be a bumpier ride than previously thought. The economy’s growth rate should crater this year at 0.2%. However, the Fed expects the pace next year to rise to 1.2%, this despite the significant jump in financing costs for households and businesses and a higher unemployment rate.

The expected rate increases reflect the Fed’s determination to quell the highest bout of inflation since the early 1980s. This pace of interest rate increases is the fastest since 1980 (see chart 2). The Fed made it clear: “The committee [FOMC] is strongly committed to returning inflation to its 2% objective.” That is consistent with their previous messages that inflation is public enemy number one.

Fed Chair Jerome Powell had previously asserted that the Fed could raise interest rates enough to tame inflation without causing a recession (the so-called “soft landing”). But recently he altered that message a bit, acknowledging that higher interest rates and a slower pace of economic growth “will bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”

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