US Fed forecasts show fraying faith in soft landing

The Federal Reserve's aggressive drive to bring inflation down to its 2 per cent target will take years to complete and come at a cost of notably higher unemployment and slower economic growth, according to projections from policymakers published on Wednesday that cast doubt on prospects for a so-called "soft landing."

The Fed's latest quarterly summary of policymaker projections shows US central bankers expect to raise the policy rate, now in the 3 per cent-3.25 per cent range after Wednesday's 75-basis-point increase, to 4.4 per cent by the end of this year and to 4.6 per cent by the end of next year, according to the median estimate of all 19 Fed policymakers.

The rate hikes are the sharpest since the last time the Fed, under Paul Volcker's leadership, battled super-high inflation in the 1980s. But back then, Volcker had to drive borrowing costs well into the double digits to vanquish inflation; even the most hawkish Fed policymaker today sees rates rising only to 4.9 per cent next year, Wednesday's projections show.

Fed Chair Jerome Powell is hopeful that the projected rate path will do the job, allowing him to avoid the high costs imposed by Volcker's actions, including 10.8 per cent unemployment.

But the projections do show Americans are in for some pain ahead as the Fed works to end inflation and prevent what Powell says would otherwise be even worse outcomes.

Unemployment forecast in focus

Inflation by the Fed's preferred measure - the personal consumption expenditures price index - is expected to be 5.4 per cent in the last quarter of this year before cooling to 2.8 per cent in the final quarter of next year, the projections show. By the end of 2024 policymakers see inflation at 2.3 per cent, and easing to its 2 per cent target by the end of 2025.

Meanwhile, policymakers expect their interest-rate hikes to push the unemployment rate, now at 3.7 per cent, to 3.8 per cent next quarter and 4.4 per cent in the final quarter of 2023.

That projected increase of 0.6 percentage points indicates a recession will begin by year's end as defined by an indicator that has gained a following in recent years. The Sahm Rule, named for former Fed staffer Claudia Sahm, says the U.S. economy is typically in recession once the 3-month moving average of the unemployment rate rises half a percentage point above the rate's lowest three-month average over the preceding 12 months. That low currently is around 3.56 per cent.

Historically once the unemployment rate rises by half a percentage point, it continues to rise another point or two, if not more.

In the last forecast, issued in June, the jobless rate was seen rising to 4.1 per cent in 2024.

Wednesday's projections show Fed policymakers have also become more pessimistic about the outlook for economic growth. One policymaker saw the U.S. economy shrinking next year, the projections showed, though most did pencil in an expansion this year and next. The median projection was for GDP growth to slow to 0.2 per cent this year, compared with June's expectation for 1.7 per cent growth.