Reasons to be Optimistic

As expected, the Federal Reserve raised the target for its benchmark federal funds interest rate by 50 basis points at its mid-December meeting, to a range between 4.25% and 4.5%.

That was down from the 75 basis-point hikes at its four previous meetings, yet the market’s immediate reaction to the move was an immediate selloff.

Was that a classic “buy on the rumor, sell on the news” reaction — i.e., the Fed delivered exactly what Chair Powell had earlier indicated it would do?

Or was there some element of disappointment that the Fed, despite the more modest rate increase, included in its updated economic projections that most officials expect to raise rates by another 100 basis points, to about 5.1%, next year?

But was that really a surprise, given earlier comments from Powell and other Fed officials?

On a positive note, according to the Fed’s revised economic projections, it now expects inflation to fall to 3.1% next year before declining in 2024 to 2.5% and 2.1% in 2025, putting it at its long-term target.

In November, the year-on-year increase in the consumer price index fell to 7.1% from 7.7% a month earlier, down sharply from June’s 9.1% peak. So it looks like the Fed is optimistic about where inflation is headed, whether its rate-rising regimen deserves the credit or not.

It's also now calling for U.S. GDP to grow by 0.5% next year, unchanged from this year’s pace, before climbing to 1.6% in 2024.

By way of comparison, the economy rebounded at an annual rate of 2.9% in the third quarter following two straight quarters of negative growth.

The Fed projects the unemployment rate to jump to about 4.5% over the next three years, up from 3.7% currently, due to its rate increases.

(Which begs the question: Whatever happened to the Fed’s mandate to promote full employment? I guess it can’t do that and fight inflation at the same time.)

The Fed has a fairly light schedule in the first part of next year, so interest rate moves are likely to be few and far between anyway. The Fed’s next monetary policy meeting isn’t until the end of January, followed by one in the middle of March, and another one at the beginning of May.

Of course, the Fed could always announce a rate move — either up or down — in between meetings, but it usually only does so in times of crisis.

While investors seemed to be disappointed that we can expect another 100 basis points or so in rate increases, it’s important to put that in perspective.

After all, the fed funds target rate was near zero at the beginning of this year until the Fed started raising rates, by 25 basis points, in March, followed by six more, including the latest one. That would indicate that most of the pain is already behind us, with only a little more—hopefully—ahead of us, if you believe the Fed’s dot-plot chart.

So far, it seems, businesses and consumers by and large haven’t been terribly inconvenienced by all this, as attested by the third quarter’s 2.9% jump in GDP. The Christmas shopping season looks robust. The (few) restaurants I’ve been to have been full, as have the parking lots I’ve driven by.

There are other reasons for optimism. “Supply chain bottlenecks” were constantly in the news at the beginning of this year, but you don’t hear much about them anymore, do you? That’s because more companies have moved their supply lines on-shore or near-shore and away from Asia, while China seems to be relaxing its draconian Covid restrictions, or at least says it is. That should reduce inflationary pressures.

And despite dire predictions following Russia’s invasion of Ukraine last February that oil prices were headed to the stratosphere, prices have done the exact opposite and are projected to drop still lower even as we enter the teeth of winter. The world has managed.

While nobody’s happy about the level of partisanship in Washington, the results of the most recent elections are also a reason for optimism. With Democrats controlling the Senate and Republicans the House, political gridlock may be the happy result, as Congress and the Biden White House will have fewer opportunities to screw things up further than they already have.

Could this rosy scenario come unraveled in 2023? Of course.

Maybe inflation will remain stuck in the mid-single digits — or spike even higher — in which case the Fed will feel compelled to be more aggressive in raising rates, resulting in weaker economic growth and more job losses.

Maybe oil prices will increase as the weather gets colder.

Maybe the war in Europe will get even uglier.

Maybe some unforeseen Black Swan event will occur somewhere.

But right now it appears that the worst is behind us.

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.