The Federal Reserve's latest economic projections show the federal funds rate overshooting its expected longer run level, prompting worries from some analysts that an overly hawkish path of rate hikes could usher in the next recession.
After the March 21 meeting of Federal Open Market Committee, analysts are pointing to the Fed's higher projections for rate hikes in 2019 and 2020 as a factor that might complicate a soft landing, where the Fed can raise rates enough to stave off inflationary pressures but not halt the economic expansion.
"Just remember that of the thirteen Fed tightening cycles in the post-WWII era, 10 landed the economy in recession," David Rosenberg, chief economist and strategist at Gluskin Sheff and Associates Inc., pointed out in a note to clients after the FOMC raised its benchmark interest rate by 25 basis points.
The latest projections from the Fed show officials expect they will take a steeper path on rate hikes in 2019 and 2020 — just as the effects of U.S. tax cuts fade and inflation is expected to pass the Fed's 2% target. Officials are now signaling they might raise rates three times in 2019, up from their projection of two at their December meeting.
By the end of 2020, the median FOMC projection puts the benchmark rate at 3.4%. That is above the 2.9% estimated by Fed officials for the longer-run federal funds rate.
Michael Pearce, senior U.S. economist at Capital Economics, is forecasting the Fed will need to begin cutting interest rates again in 2020, as the effects of the tax cuts dwindle. "Ultimately, that cumulative monetary tightening, combined with the fading boost from fiscal stimulus, results in a downturn in the economy," he said in an interview.
At his first news conference, though, Fed Chairman Jerome Powell cautioned against reading too much into forecasts that are so far away. The projections, he said, would be "modestly tightening policy" but are three years from today. "It's highly uncertain," he told reporters. "You know, we don't have the ability to see that far into the future, so I really wouldn't put a lot in that."
Indeed, some say there are a few unusual assumptions in the Fed's projections going forward.
The unemployment rate, for example, is projected to drop to 3.6% in 2019 and 2020, significantly below the levels Fed officials previously expected. Yet despite an unusually tight labor market — the jobless rate has not dropped to that level since 1969 — the Fed is not projecting a significant spike in inflation. Fed officials instead projected inflation will just slightly overshoot its 2% target in 2019 and 2020, putting the expected figure for their preferred inflation gauge at 2.1% in both of those years.
"Taken all together, these numbers simply don't add up," wrote Megan Greene, chief economist at Manulife Asset Management, adding she is "skeptical of this hawkishness" from the Fed.