Economists believe the Fed will continue to raise rates despite banking turmoil

The Federal Reserve will continue to raise its base rate, keeping it above 5.5% through the end of the year, despite the turmoil in the US banking sector, according to most of the leading academic economists polled by the Financial Times.

The latest survey, conducted in partnership with the Global Markets Initiative at the University of Chicago’s Booth School of Business, shows that the US central bank still has work to do to root out stubbornly high inflation, even as it fights a crisis among mid-sized lenders. after the collapse of Silicon Valley Bank.

Of 43 economists surveyed between March 15 and 17, just days after U.S. regulators announced emergency measures to stop contagion and strengthen the financial system – 49 percent predict the federal funds rate will peak between 5.5 and 6 percent this year.

This is more than 18 percent previous poll in December and compared with the current rate between 4.50% and 4.75%.

Another 16 percent believe it will peak at or above 6 percent, while about a third believe the Fed will stop short of those levels and cap its so-called “marginal rate” below 5.5 percent. Moreover, almost 70% of respondents said they do not expect the Fed to cut before 2024.

The policy path proposed by most economists is noticeably more aggressive than current expectations reflected in the federal funds futures markets, highlighting uncertainty overshadows not only the Fed’s interest rate decision on Wednesday, but also the trajectory for the coming months.

Traders from last Friday decreased how much more the Fed will squeeze the economy, given concerns about financial stability. Now they’re betting that the central bank will only raise interest rates by another quarter of a percentage point before ending its tightening campaign. This would mean a final rate just below 5 percent. They also raised bets that the central bank would quickly reverse course and make cuts this year.

“The Fed is really caught between a rock and a hard place,” said Christiane Baumeister, a professor at the University of Notre Dame. “They must continue to fight inflation, but now they have to do it amid heightened tensions in the banking sector.”

Baumeister, who participated in the poll, urged officials not to “prematurely” end their monetary tightening campaign, calling it “a matter of maintaining the Fed’s credibility as an inflation-fighter.”

Roughly half of respondents said the SVB events caused them to cut their federal funds rate forecasts by 0.25 percentage points by the end of 2023. About 40 percent were evenly split between a rout that didn’t change anything, or perhaps more tightening at the end, and a half-point easing of central bank policy.

The majority felt that the actions taken by the authorities were “sufficient to prevent further bank runs during the current cycle of tightening interest rates.”

John Steinsson of the University of California, Berkeley was one of the panellists who concluded that the Fed and its regulators had successfully contained the unrest and said that “a major change in the tightening cycle would be a mistake.”

The more hawkish stance stems from a more pessimistic view of the inflation outlook.

Most economists polled expect the Fed’s preferred target – the main price index for personal consumption spending – to remain at 3.8% by the end of the year, about a percentage point below its January level but still well above the central bank’s 2% target. . . In December, the average core PCE estimate at the end of 2023 was 3.5 percent.

In fact, nearly 40 percent of respondents said it was “somewhat” or “highly” likely that PCE would still be above 3 percent by the end of 2024. This is about twice as much as in December.

Deborah Lucas, an MIT finance professor who participated in the survey, said she takes a softer view of the inflation outlook but warned that the Fed’s tools are largely ineffective in addressing what she sees as a supply-side problem. turmoil, “aggressive” fiscal policy, and increased American savings.

“What the Fed will do if it raises interest rates too aggressively is to cut back on needed investment and do little to inflation,” she said.

One ongoing debate is how bad the credit crunch is across the country as the regional banking sector shuts down.

Stephen Cecchetti, an economist at Brandeis University who previously headed the Bank for International Settlements’ monetary and economics department, said he expects demand to “recede” overall.

“Financial conditions are tightening and they are not doing anything,” he said of the Fed.

A weak majority expects the National Bureau of Economic Research — the official arbiter of when U.S. recessions start and end — to declare a recession in 2023, with most holding that it will happen in the third or fourth quarter. In December, most thought it would happen in the second quarter or earlier.

However, the recession is projected to be shallow, with the economy still growing at 1 percent in 2023. Meanwhile, the unemployment rate is projected to rise to 4.1 percent by the end of the year, from the current level of 3.6 percent. . It will eventually peak between 4.5% and 5.5%, according to 61% of economists.