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As the 17-year hike draws to a close, can maintaining growth and reducing inflation be achieved simultaneously?

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As the 17-year hike draws to a close, can maintaining growth and reducing inflation be achieved simultaneously?

The Federal Reserve ended its final FOMC meeting of the year in the early hours of December 15th in Taiwan, with all members in agreement to raise the federal funds rate by 2 basis points. The target range is now set at 4.25% to 4.5%, and they hinted at maintaining a tightening policy next year.

A Year of Strong Interest Rate Hikes

Starting from March this year, the Federal Reserve discovered that inflation was not just a temporary effect as expected. With the outbreak of the Ukraine-Russia war, soaring oil prices, and supply chain issues, inflation continued to rise. The Fed has initiated its strongest interest rate hike cycle since 1980, increasing the federal funds rate from 0.25% in January to 4.5% yesterday, with a staggering 17 hikes. The interest rate has now reached a 15-year high.

Fed Chair Powell pointed out that the key now is to continue to curb inflation. Historical experience shows that the Fed should not consider easing interest rates too early. It should not consider cutting rates until all members confirm that inflation has returned to the 2% level. According to the rate dot plot released this time, out of the 19 Fed members, 17 estimate that the benchmark interest rate will be higher than 5% next year. Additionally, 7 members believe that the rate will rise to above 5.25% in 2023, indicating that interest rates will continue to rise next year and remain high for some time, possibly not decreasing until 2024. This has disappointed many investors as many experts previously expected a rate cut in the second half of 2023.

Lowering Economic Growth Forecasts

The Fed has lowered its 2023 economic growth rate forecast to 0.5%, down from the previous estimate of 1.2%, while the unemployment rate has been raised to 4.6% from 4.4%. The preferred inflation indicator for the members, the core personal consumption expenditures price index (PCE), is estimated to rise to 3.5%, up from the previous forecast of 3.1%. It is apparent that the Fed also believes that under unchanged interest rate policies, the economy will weaken in the next year, and the unemployment rate will rise.

As for the yield curve that investors are concerned about, the yield on the 10-year U.S. Treasury bond has reached 3.5%, while the 3-month yield has reached 4.38%. The inversion has widened to 88 basis points, indicating that market concerns about an economic recession continue to rise.

3% Seems to Be a Better Strategy

In response to the Fed's continued inflation target of 2%, Bill Ackman, the billionaire founder of the asset management company Pershing Square Capital, has a different view. He believes that factors such as deglobalization, transition to alternative energy, wage increases, and the demand for lower risk and shorter supply chains are all contributing to inflation. The Fed cannot change its target now, but it may do so in the future.
Bill Ackman believes that businesses need price stability but can thrive in a world with stable inflation at 3%. He also believes that the Fed cannot avoid restoring inflation to 2% in a severe recession that disrupts employment, and even if it returns to 2%, it cannot stay there stably in the long term. Accepting 3% inflation as a long-term strategy to achieve strong economic growth and employment growth would be a better strategy.