Fed Meeting to Focus on Interest Rates’ Coming Path

The official and some private-sector economists have warned of the growing risk that the Fed will raise rates too much and cause an unnecessary sharp slowdown. As of June, the Fed had not raised interest rates by 0.75 points, or 75 basis points, since 1994.

“They need to think about calibration at this meeting. You’re trying to cool the economy, not freeze it,” said Diane Swonk, chief economist at KPMG.

Fed officials widely supported a supersize rate hike this summer as they played catch-up. Inflation has been nearing 40-year highs, but interest rates have been pegged near zero until March. The debate over how much more to raise rates could intensify as they reach levels more likely to hold back spending, hiring and investment. The fed funds rate affects other borrowing costs throughout the economy, including rates on credit cards, mortgages and car loans.

“They need to slow down. Let’s remember, 50 basis points is fast; 75 basis points is really fast,” said Ellen Meade, an economist at Duke University who is a former senior adviser at the Fed.

December would be a natural time to slow the pace of rate hikes because officials could use the new projections at the meeting to show they expect to reach a higher peak or terminal interest rate than they previously expected, he said. The debate over the speed of the increase can obscure the more important one of how high rates end up rising. “Going faster now is about raising the terminal rate,” Ms Meade said.

But some analysts said it would be difficult for the Fed to dial back the pace of rate hikes in December because they expect inflation to continue to run hotter than other analysts forecast. Fed officials had expected inflation to decline this year, but that view has been futile so far. They responded by targeting a higher destination for the fed funds rate than they projected earlier in the year, resulting in a longer-than-expected streak of 0.75 point rate hikes.

Officials at their September meeting projected that they would need to raise rates to at least 4.6% early next year. “If you have broad agreement on that and inflation continues to rise higher than expected, it makes sense to hit that peak rate early,” said Matthew Luzzetti, chief US economist at Deutsche Bank.

Analysts at Deutsche Bank, UBS, Credit Suisse and Nomura Securities expect the Fed to follow a 0.75-point rate hike this week with an increase of the same size in December.

Meanwhile, analysts at Bank of America, Goldman Sachs, Morgan Stanley, and Evercore ISI see the Fed dialing back the pace of rate hikes in December with a 0.5 point increase.

Economic data released since the September Fed meeting has been mixed. Despite slowing domestic demand and the housing market entering a sharp downturn, the job market remains strong and inflationary pressures continue to rise. Recent earnings reports have shown strong consumer demand and rising prices.

Officials will look at two more months of economic reports before their mid-December meeting, including on hiring and inflation. “Even if Powell gives guidance at his press conference, it will not involve commitment. That’s because the decision has to be determined by the data,” wrote former Fed governor Laurence Meyer, who runs the economic forecasting firm LH Meyer Inc., in a recent report.

Some economists say the Fed will need to raise the fed-funds rate higher than 4.6% next year because of the resilience of consumer spending and domestic demand to higher rates so far.

Strategists at FHN Financial expect the Fed to raise its key rate to around 6% by next June. After this week’s hike, the Fed could achieve that without another 0.75 point rate hike.

“The obvious dilemma for financial markets is that many things can be true at once, and many of them pull in different directions. The Fed may slow in December, but then still hit 6% in our forecast,” said Jim Vogel of FHN Financial, in a note to clients Monday.

The Fed fights inflation by slowing the economy through tighter financial conditions—such as higher borrowing costs, lower stock prices and a stronger dollar—that curb demand. Changes to the expected rate trajectory, and not just what the Fed does at any given meeting, can affect broader financial conditions.

Many investors this year have been eager to interpret signs of a less aggressive rate hike as a sign that a pause in rate hikes is not far off, but the continued market rally risks undoing the Fed’s work to slow the economy.

Any discussion by Mr. Powell about how officials view the potential path of higher rates could dampen any market enthusiasm about slower rate hikes, economists said. “It’s now about the destination, not the journey,” Michael Gapen, chief US economist at Bank of America, said in a report Monday.

Write to Nick Timiraos at [email protected]