September Sees Fed Dot Plot Thicken: Mike Dolan, Reuters

By Mike Dolan

LONDON – Markets seem to be shifting their focus from next month’s Federal Reserve meeting, regarded as a pause, to speculations about a potential rate hike in November. This upcoming gathering could be crucial in determining the conclusion of the tightening cycle.

Fed Chair Jerome Powell made a firm reiteration of the central bank’s commitment to combatting inflation during the Jackson Hole symposium. Without any significant policy changes, his determination appeared to resonate with the market.

After weeks of uncertainty, particularly as the U.S. economy picked up speed in July, traders are beginning to align with the Fed’s stance that one more rate hike is likely. Futures markets, for the first time since the banking upheaval in early March, indicated a 60% probability of another increase to the 5.50-5.75% range by the Fed meeting on November 1.

Despite the ever-changing landscape, market sentiments appear to be more aligned with the Fed’s outlook on its peak interest rate. For most of the year, the median projection for year-end rates from Fed policymakers has suggested a higher endpoint than the rates implied in futures markets.

The March banking crisis had led to a temporary reassessment of the impact of previous rate hikes on credit conditions. Yet, despite a notable slowdown in credit creation, falling inflation, a tight labor market, and rising real wages have sustained demand. The Atlanta Fed’s GDPNow model recently indicated a real, inflation-adjusted economic growth rate of 5.9% for the current quarter, its highest estimate since January of last year.

Throughout the uncertainties of spring, Fed officials remained steadfast in their year-end projections, only raising it slightly to 5.6% during the March crisis. Monitoring this projection would have provided a clearer picture of market trends compared to the more volatile policy rate futures.

Investors expect the Fed to await a couple more months of economic data before determining its next steps, leading to the assumption that any further moves will be made on November 1 rather than in September, which many view as a ‘dead rubber’ meeting focused on gathering more information.

However, the September meeting could still reveal important insights, including an updated dot plot that indicates the Fed’s perspective on the end of the tightening cycle. Given the Fed’s recent accuracy in interpreting economic trends, such forecasts could carry significant weight.

If the Fed maintains its stance, it could solidify the current outlook; another increase in the median dot could signal potential additional hikes, placing a 6% rate unexpectedly close on the horizon. Current market anxieties surrounding prolonged higher rates might prompt revisions in the Fed’s expectations for rate declines through 2024.

The question lingers: Has the Fed successfully aligned the market with its objectives, or is it simply fortunate in its economic predictions?

Recent research from San Francisco Fed economists noted a resurgence in disagreement among Fed policymakers regarding the economy’s strength and inflation trends. This rise in differing views suggests less clarity than it may appear.

Skepticism around a ‘soft landing’ persists. Economists from JPMorgan warned that while avoiding a recession this year is positive, it does not guarantee an extended period of economic growth. They highlighted that historically, there have been no sustained expansions following massive and synchronized tightening across developed economies, although some exceptions exist after significant Fed rate hikes.

To replicate past successes, the economy must maintain job growth despite declining profits, the Fed would need to ease within six months of the last hike—an unlikely prospect now—and a new growth catalyst might be necessary.

Thus, while optimism exists, the outlook remains cautious, and the journey ahead is still uncertain.