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'The Fed has some catching up to do' — What to expect from the Federal Reserve on Wednesday

Myles Udland
Markets Reporter

A Fed rate hike is coming on Wednesday.

At 2:00 p.m. ET on Wednesday, the Federal Reserve will announce its latest monetary policy decision with markets expecting the central bank to raise interest rates by 25 basis points for the third time this year. This move would bring the target range for the Fed Funds rate to 2%-2.25%, setting the fed funds rate at around 2.13%, the highest since April 2008.

“Inflation is at target, the unemployment rate is below target and falling, and yet the funds rate remains 100bp below the Fed’s estimate of its neutral level,” said Goldman Sachs economists Jan Hatzius and David Mericle in a note published last week. “Most FOMC participants now agree that this makes little sense — the Fed has some catching up to do.”

Alongside its latest policy decision, the Fed will also release an updated summary of economic projections with Fed Chair Jerome Powell holding a press conference that will begin around 2:30 p.m. ET. Next year, the Fed will hold press conferences after each of its eight annual meetings, giving the FOMC more flexibility to raise rates at any meeting. Over the last few years, the Fed has only raised rates — markets have only anticipated a move — at one of the Fed’s four meetings currently followed by press conferences.

The Federal Reserve will surprise no one if it does Wednesday, Sept. 26, what it’s poised to do for a third time this year: Raise its key short-term interest rate by a modest quarter-point to help keep inflation in check, and signal that another hike is likely in December. (AP Photo/Jose Luis Magana)

The Fed’s updated economic projections will include the latest “dot plot,” a forecast of median expectations for interest rates at the end of this year and each of the next three, along with an estimate of the Fed’s longer-run neutral rate that would support full employment and price stability. In June, the Fed’s forecast indicated that two more rate hikes this year were likely with the FOMC split on whether two or three rate hikes would be warranted in 2019.

Wednesday’s economic projections will also give markets their first look at the Fed’s forecasts for 2021, which Goldman says will “offer insight into the Fed’s plan to manage the overshoot of its labor market target.”

“With policy rates projected to be in restrictive territory in 2020, it’s reasonable to expect GDP growth [in 2021] will be at or slightly below the Committee’s median estimate of longer-run growth—1.8%,” said JP Morgan economist Michael Feroli. “That might be enough to justify the unemployment rate projection moving up a tick in 2021, even as PCE inflation continues to run only a tenth above the Fed’s 2% objective.”

In June, Fed watchers were struck by the central bank’s forecast of an unemployment rate expected to be a full percentage point below its long-run estimate through the end of this decade. In other words, the labor market is currently stronger than what the Fed thinks will be required to sustain 2% inflation and the Fed expects this trend to continue for years. Expect Powell to field a number of questions on this topic.

Since the Fed’s latest rate hike in June, stocks have hit all-time highs in the U.S. while emerging and international stocks have remained under pressure as President Donald Trump’s trade fights with China and other trading partners have continued.

In its most recent policy statement published August 1, the Fed did not make reference to international developments or trade fights, saying only that risks to its outlook appear “roughly balanced” and calling the U.S. economy “strong” in three different contexts.

But as Fed policy begins to shift from being accommodative towards a neutral or even restrictive stance, the discussion among market participants has increasingly focused on the next economic downturn and the role the Fed might play.

“With unemployment now noticeably below standard measures of its natural level of full employment and likely to tighten further and with wage and price inflation returning to desired levels and likely to continue upward, the Fed has a delicate task on its hands,” said Deutsche Bank economists in a note last week. “[The Fed] needs to begin to close the gap between growth of aggregate demand and aggregate supply in the economy — in other words, to slow and eventually reverse the tightening of the labor market before it risks pushing up inflation and inflation expectations excessively.”

The firm, however, thinks the Fed has a decent chance at engineering a soft landing for the U.S. economy — or an increase in unemployment without a recession — a task which has not been achieved since World War II.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland