In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Sunday, January 08, 2023

Question #6 for 2023: What will the Fed Funds rate be in December 2023?

by Calculated Risk on 1/08/2023 12:22:00 PM

Earlier I posted some questions on my blog for next year: Ten Economic Questions for 2023. Some of these questions concern real estate (inventory, house prices, housing starts, new home sales), and I’ll post thoughts on those in the newsletter (others like GDP and employment will be on this blog).

I'm adding some thoughts, and maybe some predictions for each question.

6) Monetary Policy: In response to the increase in inflation, the FOMC raised the federal funds rate from "0 to 1/4 percent" in January 2022, to "4-1/4 to 4-1/2 percent" in December. A majority of FOMC participants expect three or even four 25 bp rate hikes in 2023.  What will the Fed Funds rate be in December 2023?

Fed Chair Jay Powell and rest of the FOMC are still hawkish.  For example, from Neel Kashkari, President of the Federal Reserve Bank of Minneapolis spoke on January 4, 2023: Why We Missed On Inflation, and Implications for Monetary Policy Going Forward .  He is expecting 4 more rate 25bp rate hikes in 2023:
"In my view, however, it will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked.

Once we reach that point, then the second step of our inflation fighting process, as I see it, will be pausing to let the tightening we have already done work its way through the economy. I have us pausing at 5.4 percent ..."
And Wall Street economists are expecting three or more rate hikes this year.  From Goldman Sachs on January 6, 2023:
"We continue to expect 25bp fed funds rate hikes each in February, March, and May. We continue to expect no rate cuts in 2023."
From BofA on Jan 6, 2023:
"We continue to expect the Fed to lift the target range to 5.0-5.25% early this year, a view that the Fed appeared to tentatively endorse. We expect a 50bp rate hike in February and 25bp increase in March."
As of December, looking at the "dot plot", the FOMC participants see the following number of rate hikes in 2023:

25 bp Rate Hikes FOMC
No Change0
One Rate Hike0
Two Rate Hikes2
Three Rate Hikes10
Four Rate Hikes5
Five Rate Hikes2

Clearly the main view of the FOMC is three or even four rate hikes in 2023.

Recently there has been discussion of the monetary lag being short (hawkish).  For example, from economists Taeyoung Doh and Andrew T. Foerster at the Kansas City Fed: Have Lags in Monetary Policy Transmission Shortened?
In summary, we find evidence for a shorter lag in the peak response of inflation to a policy shock in the post-2009 period even after we adjust the shock definition to incorporate forward guidance and balance sheet policy.
And from Goldman Sachs:
There are two reasons why we believe the lags from monetary policy to growth are short while many others believe they are long. First, in our framework a tightening in financial conditions starts to affect the economy when financial markets react to expected policy changes instead of when rate hikes are delivered. Second, many commentators confuse lags from monetary policy to GDP growth with lags to GDP levels.
However, employment changes still lag policy. How many construction jobs have been lost so far? None. In fact, construction employment is at an all-time high since there are a record number of housing units under construction! These job losses are already in train with a longer than normal lag due to supply chain issues, and this will increase unemployment and slow wage growth.

The next FOMC meeting ends on February 1st, and it appears the Fed is poised to raise rates 25 bp at this meeting (maybe even 50 bp). However, based on slowing wage growth, core inflation ex-shelter already being negative for two consecutive months, and overall inflation slowing quickly, I think there will be fewer increases this year than most analysts currently expect. My guess is there will be around 2 rate hikes in 2023, and if there are more, the FOMC will be under pressure later in 2023 to cut rates putting the Fed Funds rate under 5% at the end of 2023.

Here are the Ten Economic Questions for 2023 and a few predictions:

Question #1 for 2023: How much will the economy grow in 2023? Will there be a recession in 2023?
Question #2 for 2023: How much will job growth slow in 2023? Or will the economy lose jobs?
Question #3 for 2023: What will the unemployment rate be in December 2023?
Question #4 for 2023: What will the participation rate be in December 2023?
Question #5 for 2023: What will the YoY core inflation rate be in December 2023?
Question #6 for 2023: What will the Fed Funds rate be in December 2023?
Question #7 for 2023: How much will wages increase in 2023?
Question #8 for 2023: How much will Residential investment change in 2023? How about housing starts and new home sales in 2023?
Question #9 for 2023: What will happen with house prices in 2023?
Question #10 for 2023: Will inventory increase further in 2023?