The Federal Reserve Open Markets Committee (FOMC) announced at its September meeting that it would hold interest rates steady this month, addressing a complex landscape of economic indicators that have shown both robust growth and unique challenges.

The central bankers also indicated they are still vigilantly watching all the economic indicators and that they are willing to raise rates before the end of the year if it seems necessary. Shawn Snyder, Global Investment Strategist at J.P. Morgan, noted the ambivalence surrounding this possibility. “As it stands right now, financial markets are putting the odds of another rate hike in 2023 at about the same as a coin flip.” He continued, “We think the Fed is most likely done with rate hikes, but wants to retain the option for another hike should inflation and growth reaccelerate more-than-expected.”

Inflationary trends

One of the primary concerns for the Federal Reserve for almost two years has been the elevated rate of inflation. In this regard, the latest data offers some comfort. Inflation, which peaked at highs in 2022 not seen since the 20th century, has largely downshifted. Although there have been notable pressures on the economy in recent weeks, in particular oil and gasoline prices that have crept upwards and put pressure on consumers’ spending, the general consensus is that inflation will continue to decelerate in the coming months.¹ Specific sectors like the automobile and housing markets that have shown easing prices for cars and rent are considered pivotal to inflation’s continued decline.

Economic growth exceeds expectations

Contrary to the inflationary landscape, the economic growth trajectory has been bullish. When we rewind to June, the median projection from Fed officials for the full-year gross domestic product (GDP) growth was a modest 1%.² However, recent indications have shattered this conservative forecast, with the likelihood of the economy growing at a rate greater than 2% in 2023. This surge in growth has challenged the conventional wisdom that a period of below-trend growth is essential to curtail inflation. “Economic activity has been stronger than we’ve expected, stronger than anyone expected,” said Chairman Jerome Powell at the press conference announcing the rate decision.

The driver of this growth has been the strength and resilience of the American consumer, who has continued to spend in the face of rising costs. Still, Powell said the Fed expects the economy to cool, “with median projections coming in at 1.5% next year.” He furthered, “I’ve always thought that the soft landing was a plausible outcome. This may be decided by factors that are outside our control, at the end of the day.”

Stock market performance

The robustness of the U.S. economy is mirrored in its stock market performance. 2023 has been a remarkable year for investors, with the S&P 500 experiencing a surge of 16%. However, the tech-centric Nasdaq Composite Index outshone the broader market by almost doubling its performance, boasting an impressive growth of over 30%. It should be noted though that the strong performance comes on the back of tech sector outperformance. Absent these concentrated gains, performance would have been more muted.

Concerns over depleting savings and consumer spending

During the pandemic, Americans amassed excess savings, which at its zenith was estimated to be over $2 trillion. Yet, as per the forecast by economists at the San Francisco Fed,³ this financial buffer could deplete this quarter. A significant decline in these savings could translate to reduced consumer spending, which will adversely affect growth in 2024.

Further exacerbating concerns about consumer spending is the increasing cost of gasoline, which is now hovering around an average of $3.85 a gallon. As gasoline prices remain elevated, there's a looming fear that consumer spending might get stifled further, given that fuel expenses take up a considerable portion of household budgets.

Capital flow challenges

Another dimension of the economic landscape is the behavior of banks in response to the Federal Reserve's interest rate hikes. To adjust to this monetary policy decision, banks have significantly reduced the flow of capital to businesses. This curtailment has the potential to hinder entrepreneurial growth and innovation, two essential components of a resurgent U.S. economy.

One more hike in 2023, steady on in 2024

The Federal Reserve Open Markets Committee continues to walk a narrow path between doing too little and doing too much. On one hand, policy makers and history buffs fear a return to the inflation spiral of the 1970s when the Fed raised and lowered interest rates over the course of a decade and not only didn’t stop inflation, but seemed to stoke it. On the other hand, no one wants the Fed to create an unnecessarily challenging economic environment when the scarring effects of the pandemic are still top-of-mind for many.

The consensus among Fed officials (as reflected in the famous “dot plot” of FOMC participants’ assessments of appropriate interest rate levels) is that rates will trend down in 2024 and 2025.⁴ Powell made clear in his spoken remarks that real rates are now positive, even as the economy grows and inflation recedes, which gives the Fed some wiggle room to deal with any new, unforeseen problems on the horizon. Snyder offers a word of caution on this perspective, suggesting, “The Federal Reserve’s rosy economic outlook for 2024 was unexpected and seemed a bit more like ‘hopecasting’ than forecasting.” Time will tell.

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