Powell Doubles Down On His Hawkish Message

Scott Anderson
Chief Economist
Bank of the West

Powell, in his last public statements before the Fed's black out period going into the September 21st FOMC Meeting, did nothing to discourage the view that has been forming in the money market over the past week that the Fed will go big with another 75 basis point rate hike. Powell in remarks at the CATO Institute on Thursday noted that the "Fed needs to act now, forthrightly, strongly as we have been doing." He went on to say that "it is very important that inflation expectations remain anchored" and that the "clock is ticking" on ensuring they stay that way. The longer inflation remains well above the Fed's target the greater the concern that the public will start to naturally incorporate higher inflation into its economic decision making. He also warned against prematurely loosening policy. Other major central banks are weighing in with huge rate hikes of their own. The European Central Bank increased their policy rate by 75 basis points on Thursday, and another 75 basis point hike from the ECB may be coming at the next monetary policy meeting. This followed a 75 basis point hike from the Bank of Canada earlier this week.

In light of Powell's latest hawkish and one-sided remarks at the CATO Institute and another (suspiciously) well-timed Wall Street Journal article hinting at another 75 basis point rate hike in September, we are raising our forecast for the Fed Funds target rate to 3.875 percent at year end – a full 50 basis points higher than previous forecasts. I expect a 75 basis point hike in September, a 50 basis point hike in November, and another 25 basis point hike in December before the FOMC decides to take a pause to gauge the impact of their 375 basis points in rate hikes this year.

Fed To Hike Until Fed Funds Rate Just Below 4.0%

Fed funds futures markets have gotten the message and as of this morning raised the probability of another 75 basis point rate hike this month to around 86% with more than a 100% probability of another 50 basis point hike in November. This recalibration on where markets see short-term interest rates heading in the months ahead has prompted a sharp upward shift in the Treasury yield curve from a month ago that has be driven entirely by a big jump in real (inflation adjusted) interest rate expectations.

Real Interest Rates Jump On Fed Rate Hike Expectations

This is all due to the re-pricing of Fed rate hike expectations and how long short-term rates are expected to remain elevated. Even with the higher rate forecast at year-end we still don't expect any rate cuts from the Fed next year and still see more upside than downside risks for our baseline interest rate forecasts.

This is all more bad news for the U.S. housing outlook. Average thirty year fixed mortgage rates moved up to nearly 6.0% last week with mortgage purchase applications running 23% below year ago levels, according to the Mortgage Bankers Association. We expect 30-year mortgage rates to move above 6.3% in the first half of 2023 with this new Fed funds rate forecast. Housing affordability has already plunged on rising mortgage rates and high home prices. According to the National Association of Realtors, housing affordability in the second quarter of 2022 was lower than at the height of the last national housing bubble in 2006.

Housing Affordability Is Atrocious

There was really nothing new in our economic or inflation outlook that prompted this upward adjustment in our Fed funds rate forecasts, only an acknowledgement that the Fed still feels it is way behind the curve and not yet comfortable that inflation is on a sustainable downward trajectory. This despite a September Beige Book report released on Wednesday that painted an economic expansion that is in sharp deceleration. The report stated that economic activity was unchanged on balance since early July with five Fed districts reporting slight or modest growth and five reporting slight to modest softening. At the same time, most regions of the country are still struggling with an overheated labor market, chronic labor shortages and wage and prices pressures that have not yet been comfortably extinguished.

For now, the message coming from Jerome Powell and other top policymakers at the Fed is crystal clear. They need to overlook the growing signs of economic softness now forming in pockets of the country and sectors of our economy like housing and stay focused on bringing inflation back down to a more sustainable 2.0% path. Unfortunately, this powerful monetary medicine is likely to come with a bitter aftertaste of slower economic growth or decline, rising unemployment, and volatile financial markets.

To learn more, check out this week's U.S. Outlook Report.


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