The dot plot forecast of interest rates implies that the Fed may impose one more rate hike this year.
Summary of Economic Projections strongly imply that the central bank no longer expects a recession, which it did just six months ago, and is increasingly confident of a soft landing in the economy. But its dot plot forecast of interest rates implies that the Fed may impose one more rate hike this year, which would lift that policy rate by 25 basis points to a range between 5.5% and 5.75%. At the same time, though, the Fed also implied that 50 basis points of rate cuts are on the way next year.
To be sure, the Fed is better off keeping a rate hike later this year on the books rather than removing it and then having to push rates higher. Whatever the case, near term risks around the outlook linked to labor action in the auto sector, a possible government shutdown, the restarting of student loan payments and higher oil prices are all part of the risk matrix that the Fed must navigate as it makes policy decisions on rates in November and December. Because of the lagged impact of past rate hikes, financial stress across privately held firms in the real economy is rising, and the Fed should proceed carefully and not impose any additional rate hikes in this cycle. In our estimation, further rate hikes would be a policy error that results in a premature end to the current business cycle. In addition, as inflation falls, real interest rates rise. So even an extended pause will result in a further tightening of financial conditions. It is important to note that long-term real rates using 10-year Treasury Inflation-Protected Securities as the benchmark stand just under 2% in contrast with the 0.26% average over the past decade. A policy decision to let real interest rates rise as inflation comes down would result in an unnecessary recession. For this reason, the central bank needs to shift in a gradual and orderly fashion toward focusing on stabilizing real rates and begin preparing investors and other policymakers for rate cuts by no later than the second quarter next year to ensure the sustainability of the economic expansion.