Jason's World

Though the Federal Reserve paused rates on Wednesday, it has hinted at one more rate hike this year. The Fed also announced projections that showed increases in interest rate projections for the next two years. While the decision by the Fed at last week’s meeting was widely expected, the dramatic increase in interest rate projections for the coming years as well as the increasing likelihood of a rate hike in the remainder of the year has rattled markets.

As interest rates remain at a 22-year high, analysts are increasingly expecting that interest rates will remain close to the current elevated levels for many years to come. Fed officials have projected that interest rates will remain above 5% throughout the end of 2024, which amounts to a much slower pivot schedule than what analysts expected until recently. The Fed’s projections suggested that the interest rate will be at 5.1% by the end of 2024, which translates to only one cut relative to now, as opposed to the two to four cuts forecasted by analysts before Wednesday.

The Fed also increased their GDP growth projections for 2023 and 2024, indicating the Fed’s increased confidence in the economy short-term and providing a basis for maintaining high rates for an extended period of time. The sharp increase in interest rate projections for the next few years may be due to the higher-than-expected inflation reading earlier this month, caused by rising energy prices. 

The Fed’s decision to keep interest rates high and its assertion that the economy can withstand sustained high interest rates is belied by many factors. While the economy remains solid so far, there is a multitude of factors that could send shockwaves through this rosy outlook. While each one by itself may not do much harm, together they could be more threatening. 

The ongoing UAW strike that initially involved 13,000 workers at three plants, while modest initially, could end up curbing auto production and raising car prices if it goes on for a much longer time. Right now the strike has begun to expand, from the original 3 plants in Michigan, Ohio and Missouri to 38 other plants in 20 states. A broad strike could shave 0.05-0.1 percentage points off annual GDP growth for every week it lasts, which could be significant as the economy continues to slow-the Atlanta Fed has recently toned down its optimistic outlook for the economy in the third quarter. The strike places a further burden on an auto industry that has yet to recover to pre-pandemic levels, due to supply chain disruptions throughout last year.

The looming government shutdown could impact as much as 800,000 federal workers nationwide. A similar standoff in December 2018 ended up furloughing 300,000 employees and shaved 0.1% and 0.2% off economic growth in Q4 2018 and Q1 2019, respectively. Though the economic impacts of the shutdown can be remedied by giving federal workers back pay, the temporary decrease in growth will nonetheless undermine confidence in the economy and complicate the optimism for a soft landing, at least for a while. At a time when memories of apocalyptic predictions are still fresh, they could definitely set back confidence in the economy, and in turn, economic activity.

The resumption of student loan payments starting October 1st could cost Americans $100 billion in the coming year, and cost the US economy as a whole $70 billion a year. taking spending away from major retailers. This amounts to a roughly 0.3% decline in GDP growth, which may not amount to much on its own, but will add to the difficulties that consumers face as they run out of pandemic savings. 

The increase in oil prices, while initially being dismissed by analysts, also puts pressure on consumers’ pocketbooks and upward pressure on inflation. Oil not only influences prices through its direct role as an input for many goods, it also affects transportation costs, For example, air fares rose nearly 5% last month, dampening both air cargo activity and travel activity.

The PCE report next week will provide markets with insight into whether we are continuing to head towards the direction of higher for longer rates; after all, PCE is the Fed’s favorite inflation gauge. With a gradually slowing economy, increased interest rate expectations will hasten the slowdown. The adding of these various potential shocks to the mix, however small they are, add to the economic pressure. Judging by current economic trends and the growing pressures on the economy, an other-than-soft landing is becoming a very tangible, if not likely, possibility, and it will be caused by a thousand cuts-not by one factor but by a multitude of factors.