Federal Reserve officials are expected to shift to a slower pace of rate hikes in 2023 as inflation trends lower.
Federal Reserve members will convene from January 31 to February 1 for the first of the year’s eight regularly scheduled Federal Open Market Committee (FOMC) meetings.
During this time, Fed officials will determine how much to raise rates in February and what trajectory U.S. monetary policy needs to maintain to ensure inflation returns to the Fed’s 2% target goal. Furthermore, Fed officials will deliberate when in 2023 to actually pause rate hikes, given the Fed’s historic pace in 2022.
In 2022, the U.S. central bank raised interest rates seven times for a cumulative 4.25%, the most since 1980, according to historical data. Between June and November, the central bank raised its benchmark interest rate by 0.75% at four consecutive meetings.
Following December’s 50 basis point (0.5%) increase, Fed members began to highlight the likelihood of lower and more moderate rate increases throughout 2023. However, Federal Reserve Chairman Jerome Powell noted the importance of not jumping the gun with monetary policy decisions and instead following the economic data.
Several Fed officials have thrown support behind a quarter percentage point increase in February, including Fed Governor Chris Waller, who recently called for a lower increase at the next FOMC meeting.
A quarter-point increase next month would bring the Fed’s terminal rate to a range between 4.5% and 4.75%. The U.S. central bank projects the terminal rate to peak between 5% and 5.25%. If that is the case, two more quarter-point increases will likely follow sometime after the first increase in February.
“The FOMC’s goal in raising interest rates is to dampen demand and economic activity to support further reductions in inflation. And there is ample evidence that this is exactly what is going on,” Waller said in a January 20 discussion titled A Case for Cautious Optimism.
“Slowing in business activity is consistent with the FOMC’s goal of damping demand and reducing production so that it is in better alignment with the productive capacity of the economy,” said Waller.
“The goal is not, I would emphasize, to halt economic activity,” he pointed out.
However, Fed Vice Chair Lael Brainard suggested that the policy decisions made over 2022 occurred with a lag that has not become fully measurable yet. Brainard said that the lag creates a delay between policy action and results, which can alter the speed and magnitude of the Fed’s monetary policy stance.
“The lagged effects of earlier accommodation likely offset some of the initial effects of tightening over the course of 2022, and it is likely that the full effect on demand, employment, and inflation … still lies ahead,” Brainard said in a January 19 speech titled Staying the Course to Bring Inflation Down.
Ultimately, raising rates in smaller increments will provide Fed members “the ability to absorb more data … and probably better land at a sufficiently restrictive level,” Brainard said.
Not all Fed members are behind a 25-basis point increase, though.
St. Louis Fed President James Bullard voiced his support for a larger half-point rate increase due to the uncertainty around the trust strength of inflation in the U.S.
“Why not go to where we’re supposed to go? … Why stall and not quite get to that level?” he asked.
Once the Fed’s peak terminal rate has been reached, it will be best to hold rates steady to gauge the economic response.
After the Fed pauses, “we’ll need to remain flexible and raise rates further if changes in the economic outlook or financial conditions call for it,” Dallas Fed President Lorie Logan said in a recent speech at Texas McCombs’ Rowling Hall.
“My own view is that we will likely need to continue gradually raising the fed funds rate until we see convincing evidence that inflation is on track to return to our 2% target in a sustainable and timely way,” she said.