Fed Monitor: Fast Growth Becomes a Fed Concern

Summary of Key Issues

Current Fed View

The evolution of the SEP end-2023 inflation and unemployment forecasts shows the Fed is much more focused on the employment than on the inflation leg of its mandate (Chart 1).   

My base case is one more 2023 hike in November and three hikes in 2024, starting around mid-year. This compares with market pricing of four cuts in 2024 (Charts 2 and 3).   

With no growth in banks’ assets and therefore in reserves demand, quantitative tightening (QT) is likely to continue into 2024, based on a continued decline in the RRP and stable reserves (Charts 4 and 5).

Loose Financial Conditions

Despite the recent increase in long-term yields, financial conditions remain near the level of September 2022, when the FFR was 300bp lower (Charts 6 and 7). 

The Fed believes the banking crisis is over, though banks’ borrowing from the Bank Term Funding Facility continues to grow, if slowly (Chart 8). Large banks credit growth has peaked (Chart 9). 

The Fed’s planned increase in banks’ capital requirements could see banks tighten credit conditions, which I think the Fed would welcome. The measure has, however, elicited strong opposition from banks and from two of the Board Governors. The Fed could therefore struggle to get it implemented.

Concerns Over Growth Acceleration

Core disinflation has been limited, and inflation expectations have been rising (Charts 10 and 11).  I expect core inflation to remain sticky around 4% through 2024 (Core PCE to End 2023 Above 4.0%). As a result, I expect the Fed to resume gradual tightening around mid-2024.

FOMC members have been surprised by the resiliency of GDP growth (see the minutes of the 26 July meeting). The Atlanta Fed nowcast for Q3 is nearly 6% saar. While this is likely to get revised down, it is still three times the trend! (Chart 12). 

This could explain why Chair Powell feels less confident that the policy stance is strongly restrictive. At Jackson Hole, he warned that ‘additional evidence of persistently above-trend growth could put further progress on inflation at risk’ (Dom’s Quick Take: Powell’s JH Speech Supports More Rate Hikes in 2023-24).

Stronger growth puts the rebalancing of labour demand and supply and therefore wage moderation under threat. At JH, Powell stated, ‘Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response.’

This comment likely reflects the stabilization of the Atlanta Fed median wage YoY growth as well as the recent acceleration in MoM wage growth (Chart 13). 

While this is not my base case, continued wage acceleration could see the Fed lift its terminal rate forecast, starting with an additional FFR hike in December 2023.

Latest Statement

Latest Minutes

Current Fed Macroeconomic Forecast

Recent FOMC Comments

Markets Under-Pricing the Fed

Economic Data Still Calls for More Fed Tightening

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)