By: Phil Kernen
We may be below the peak in inflation seen last summer, but the bumpy ride and hard work are not over yet. What are the dots, and why are they moving higher?
Four times a year, the FOMC voters submit their Summary of Economic Projections (SEP) forecasts for multiple data points over the next few years. One data point is the overnight rate, currently at 4.5 – 4.75%. Because they are presented anonymously in the form of dots on a chart, the overnight rate forecast has become known as the dot plot. Estimates from the December SEP for 2023 ranged from a low of 4.875% (two dots) to a high of 5.625% (two dots), with everyone else in the middle. On average, voters project an average terminal rate between 5.0 – 5.25%, only 0.5% from where we sit now.
In his comments following FOMC meetings in December and January, Chairman Jerome Powell referenced disinflation multiple times after raising rates by 0.50% and 0.25%, respectively. Investors embraced the optimistic tone and, thinking the worst was over, pushed stock prices higher, continuing a trend that started in October. Bond prices rose too, and the enthusiasm drove futures markets to price a rate reduction towards the end of 2023.
Unfortunately, disinflation ran headlong into strong economic data, changing the narrative. We learned that the decline in job openings reversed in December, helping maintain upward pressure on wages as employers pay for scarce labor. Then the Bureau of Labor Statistics reported that employers created nearly 500,000 jobs in January, and the unemployment rate fell to 3.4%, a 53-year low. However, some economists think seasonal adjustments may have had an outsized effect. Consumer spending isn’t slowing down either, with retail sales increasing much more than expected.
Meanwhile, the inflation message changed. January CPI declined, but by much less than expected, based on the more significant declines in the second half of 2022. On top of that, CPI revisions for the second half of 2022 showed less disinflation than had been previously reported. January PCE, the inflation calculation favored by the Fed and forecast to remain unchanged from December, increased to 5.4%. Adding insult to accuracy, December PCE inflation was revised upwards, too, shaking the belief that inflation would quickly and gently coast into the Fed’s 2% target by the end of 2023.
As a result, more FOMC voters and non-voters are reasserting their hawkish voices. Since the January meeting, three of the 18 officials participating in policy-setting discussions suggested they would have favored a 0.50% increase, including regional Presidents Loretta Mester of Cleveland and James Bullard of St. Louis. In a speech on March 2, Governor Christopher Waller said that “These data underscore the view, as laid out in the FOMC’s December Summary of Economic Projections, that the fight to bring inflation down to our 2 percent target will be slower and longer than many had expected just a month or two ago.”
Every voter vows to continue searching for consistent evidence that inflation is moving downward when considering additional rate increases. The conclusion is becoming more apparent with each data release pointing to a strong labor market driving robust spending and related economic activity. The dots are moving higher when the FOMC releases the next SEP after the next meeting on March 22.