Fed forecasts two possible rate hikes by end of 2023

Yahoo Finance’s Brian Cheung reports the latest news from the FOMC.

Video transcript

KRISTIN MYERS: I want to go over to Yahoo Finance's Brian Cheung right now, who can break down the latest decision from the Federal Reserve.

BRIAN CHEUNG: Hey, sorry, Kristin. We are still awaiting the Federal Reserve announcement. And it looks like it just came out. So the Federal Reserve projecting actually, interestingly, two interest rate hikes by the end of 2023. This is a noticeable upward revisions from where we had seen the Federal Reserve put its projections in March of 2021. At that time, you'll recall that the median member of the FOMC projected no rate hikes through the end of that time horizon. This coming in the summary of economic projections. The Fed releases these every quarter.

Now, the Federal Reserve in its policy announcement not making any changes to the actual policy rate as of right now. So the Federal Reserve keeping interest rates at near zero. And no announcement, necessarily, on the Fed balance sheet. They're continuing to commit to at least $120 billion in asset purchases per month. That would include US treasuries and also agency mortgage-backed securities. But these projections are really going to be in attention. It'll be interesting to see what bond markets are doing.

But I want to read you some of the upward revisions. And it seems to make sense some Federal Reserve officials seeing the case for maybe higher interest rates a little bit sooner because of more optimism over the economic recovery. So when you look at GDP projections, for example, the FOMC now-- the median member of the FOMC now seeing the case for 7% GDP growth in the year 2021. That's a noticeable uptick from the March projection of 6.5%. And then inflation, they now expect core PCE, which is the Fed's preferred measure of inflation, to clock in at 3% for the year 2021. That's a noticeable uptick from the 2.2% that they had projected back in March.

Now, all of that is coming while the Federal Reserve still sees a lot of legwork to go in the labor market because, interestingly, the Federal Reserve not seeing any sort of change in the unemployment rate projection. They kept that same compared to their last round of forecasts in March, at 4.5% on the headline number.

Now, in the statement itself, I want to point out just some changes in the language that the Federal Reserve used. Not much changed, again, because the Federal Reserve keeping interest rates steady, but they noted that progress on vaccinations has reduced the spread of COVID-19 in the United States. Not necessarily anything new on that front, but interesting to see how they changed the language in the middle of their statement to say, quote, progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.

Now, the risks to the economic outlook remain is language that they had repeated from the April statement, the last time we had a meeting from the Federal Reserve, but that bit about the vaccination, and kind of attaching that to the caveat for how the economy is going to progress over the next few months was new in this particular June statement. Now, this was a unanimous decision. There were no dissents among the voting members of the FOMC.

And before I finish up my rant here, just two technical tweaks that are worth pointing out. First of all, the Federal Reserve did expand, or rather extend, its US dollar liquidity swap lines with nine major central banks around the world. That was set to expire in September. This is just to make sure that there's still a continuing flow of US dollars as the world continues to struggle with COVID.

And then the last bit is a very technical change with regards to the interest that the Fed pays on reserves and excess reserves. That was increased from 10 basis points, as we've seen over the last few months, to now 15 basis points. And without getting too into the nitty gritty, this is not at all raising interest rates. What this is doing is trying to guide the effective overnight borrowing rate something closer to the central of the Fed's range. We know that the Fed is targeting between 0 and 25 basis points on short-term interest rates.

That's been drifting towards the bottom end of that range, closer to zero, because of just the amount of swelling on bank balance sheets with the amount of reserves that are out there. But overall, to encapsulate what the announcement was today, interesting to see the Fed now projecting more rate hikes than we had seen in March. Again, two by the end of 2023. But at least for right now, no changes to interest rates, no changes to quantitative easing. And of course, we'll be awaiting that press conference in about 25 minutes or so.

ALEXIS CHRISTOFOROUS: Oh, definitely not a snoozer. And a bit of a surprise, as you say, now forecasting two rate hikes in 2023. And we saw a pretty aggressive move to the downside in equities once that announcement was made, Brian. The Dow was off more than 300 and the NASDAQ was off more than 100, although they're coming off those lows right now. What do you think those two rate hikes, those projected two rate hikes in '23 mean about the way the Fed is thinking about inflation? There is no word, of course, there as to whether or not they think it's going to be transient, which has been Fed chair Powell's big word, right, will inflation be temporary. Does being more aggressive on the rate front mean that perhaps the Fed is thinking differently about inflation going forward?

BRIAN CHEUNG: Not necessarily. And that's an important point that you make, which is whether or not they're mutually exclusive for Fed officials to, on one hand, think that inflation is transitory, but then on the other hand, want to have a quicker reaction to raising interest rates. And the reason for why that is is because when it comes to transitory nature, right, that could expire at any point in time. The question is, if you have two people in one room that say, well, I think that's going to be temporary, I think that's going to be temporary, they can both still have different timelines for when whatever temporary effect is being assessed will expire.

So I think the idea here is that, while some of these Fed officials do think that price pressures will be transitory, whether or not that's coming from the base effects of trying to compare current months to year-ago months that really represented the depths of the pandemic or because of supply chain disruptions that have made it more difficult for producers to find things, which is the reason why they're raising prices, well, yes, you could have two Fed officials that feel they are both in effect, but you can have one that says, well, I think those will fade and that, ultimately, that won't be an issue in six months, versus the other Fed official saying, yeah, well, I think this is going to be an issue for another one year, but then it'll still also fade away.

So I think what's very interesting as we head out of this meeting-- again, we want to clear the press conference this week to see how Chairman Powell tries to maybe put a dovish spin on these dot plots, but we will want to see in the future how Fed officials in the press or in public responses or public speeches try to explain and square those two things. Now of course, Fed Chairman Powell, for his part, probably would prefer to downplay this and say, look, at the end of the day, these dot plots are just projections.

All of this could change depending on how data come in over the next few months, or even years. And we've already heard the Fed chairman say in previous speeches that the dot plots are not necessarily the best way to read Fed policy, and that you ultimately want to make sure that you remember that the Fed is outcome-based, not outlook-based, and these dot plots are very much outlooks. So I think that's what we should expect to hear the Fed chairman say in about 24 minutes or so.

KRISTIN MYERS: All right, Brian, thanks so much for breaking all of that down for--