September FOMC forecasts for growth and inflation
Substantial revisions to the Fed’s 2021 growth and inflation forecasts were met with a similarly large increase in the projected median rate path through 2023. Although the currently elevated level of inflation is still forecast to moderate in 2022, FOMC members projected a faster pace of hikes throughout the forecast horizon. The SEP median estimate for 2021 real GDP growth was adjusted down to 5.9% (versus 7.0% in June), while 2022 real GDP was adjusted up to 3.8% (versus 3.3% previously). The median 2021 core PCE inflation forecast was revised higher to 3.7%, and the 2022 and 2023 medians also rose 0.2 to 0.1 percentage points to 2.3% and 2.2%, respectively. (PCE, or personal consumption expenditures, is the Fed’s preferred inflation measure; it is typically a few tenths of a percentage point lower than CPI.)
These forecast changes prompted Fed participants to lift their projections for the path of interest rates as well, and this includes the most dovish members, who shifted their expectations for the first rate hike to 2023, and the more hawkish, who added further hikes in 2022. Overall this resulted in a median policy rate forecast of 0.25% for 2022, and 1.0% for 2023. The September SEP also introduced 2024 rate forecasts at a median of 1.8%, indicating a projected pace of three 25-basis-point rate hikes per year between 2022 and 2024.
The Fed’s balance sheet
Against this backdrop for growth and inflation, Chair Powell confirmed that the FOMC still plans to announce the first reduction in their monthly pace of bond purchases at the November meeting. However, we believe the Fed will ultimately be constrained in how quickly it can announce tapering by the late October or early November timing for when the U.S. Treasury debt ceiling will become binding. In the past, market volatility has risen ahead of these deadlines, and the Fed will likely be planning for the scenario in which Treasury coupon payments are delayed, or in the worst case, Treasury auctions fail. As a result, we see the risk that the announcement is delayed until the December meeting. Having said that, we also see the possibility that the Fed announces a faster pace of tapering than the $15 billion monthly reduction that we’ve previously discussed. Regardless of whether the Fed starts tapering in November or December, we believe it can easily adjust the pace of tapering to end its bond-buying program by the middle of 2022. This will also give the Fed more flexibility to hike rates sooner in the event that inflation expectations accelerate and inflation turns out to be more persistent.
Bottom line
Elevated risks to inflation expectations appear to have prompted Fed officials to revise their rate hike projections higher. Previously more dovish members revised their expectations for the start of rate hikes into 2023, while more hawkish members built in additional hikes, resulting in a hawkish surprise.
