Don't Trust The Fed's Long Run Rate Forecast
Updated: Sep 18, 2020
At the September 15-16 Federal Open Market Committee policymakers extended their economic forecasts through the end of 2023. The updated forecasts show policymakers expect to hold official rates near zero until the end of 2023.
That triggered a loud "cheer" from equity investors. The happy prophecy of "free money" for three years invites more risk and speculation as investors see an endless string of equity gains.
Instead of popping the champagne investors should be cautious about taking the Fed forecasts as an accurate guide to the future path of rates.
In 2018, only two years ago, policymakers were raising official rates in the face of relatively strong growth. In October 2018, Federal Reserve Chair Fed Powell warned investors official rates will have to go much higher.
But three months later Fed Powell changed his view. Powell said the Fed hit the "pause" button on policy rates. Six months later policymakers reduced official rates, a dramatic u-turn in a relativley short period.
In the last three months, core CPI has increased 1.2%. That means if core CPI increases 0.2% a month for the next 9 months by August 2021 the year on year increase will be 3%. The last time core CPI hit 3% was 1995. Will the Fed decide to leave official rates at zero when core CPI is 3%?
The contrarian in me says that the risk on policy rates are much higher rates sooner than what is in the current Fed's forecast.