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Contrary to the expectations of investors, a majority of leading academic economists polled by the Financial Times believe that the US Federal Reserve will raise interest rates by at least another quarter-point. Over 40% of the economists surveyed predict that the Fed will raise rates twice or more from the current benchmark level of 5.25-5.5%, which is a 22-year high.
This is in stark contrast to the sentiment in financial markets. Traders in federal funds futures believe that the US central bank’s policy settings are already restrictive enough to control inflation, allowing them to keep rates on hold until 2024. However, the survey, conducted in collaboration with the Kent A Clark Center for Global Markets at the University of Chicago Booth School of Business, suggests that higher borrowing costs than expected will be necessary to fully address price pressures and bring inflation back down to 2%.
Julie Smith, a professor of economics at Lafayette College, noted that despite the earlier impact on interest-rate sensitive sectors like the housing market, they have remained surprisingly strong. This signals that there hasn’t been enough pullback from consumers to slow down the economy, which is a key concern.
Out of the 40 respondents, about 90% believe that the Fed has more work to do. Almost half of the economists surveyed expect the fed funds rate to peak at 5.5-5.75%, indicating one more quarter-point rate increase. Another 35% predict that the Fed will move up by two more quarter-point notches, pushing the benchmark rate to 5.75-6%. A small group of 8% believe that the policy rate will exceed 6%.
Once rates peak, the surveyed economists overwhelmingly believe that they will remain at that level for a considerable amount of time. Around 60% of the economists think that the first cut will happen in the third quarter of next year or later. This is almost double the proportion of economists who predicted the same timescale in June.
The survey comes just before the Fed officials’ next policy meeting, where they are likely to hold off on further action. The rapid tightening of policy since March 2022 has been one of the most aggressive efforts to reduce demand in decades. While inflationary pressures have subsided and the labor market is weakening, many economists are still concerned that the underlying momentum in the US economy is too strong and that it will be difficult to control inflation.
Gordon Hanson, a professor at Harvard Kennedy School, cautioned against the Fed being too quick to relax its stance. He compared it to concerns that the Fed was too slow to react, emphasizing the need for a balanced approach.
Since June, the respondents of the survey have doubled their forecasts for economic growth by the end of the year, estimating it at 2%. The unemployment rate is projected to stabilize at 4%, while the Fed’s preferred inflation gauge is expected to decrease to 3.8%. As of the latest data in July, it is at 4.2%.
By the end of 2024, only a third of the economists consider it unlikely that core inflation would exceed 3%. The majority believe that there is an equal chance or more that it will exceed that rate. The risk of curtailing oil supply is seen as the biggest threat to the inflation outlook.
Christiane Baumeister, a professor at the University of Notre-Dame, expressed concerns about energy prices following Saudi Arabia and Russia’s decision to cut supply. She expects prices to rise further, potentially leading to higher expectations of future inflation and delaying the decrease in core price growth if companies pass on the increased costs to consumers.
The sharp slowdown in China’s economy could offset this, as it is expected to drag down global growth in the coming months. Domestically, factors such as the return of student loan payments and the threat of a government shutdown may also weigh on demand.
Sebnem Kalemli-Özcan, an economist at the University of Maryland, believes that the neutral rate of interest, which neither stimulates nor suppresses economic growth, is currently higher than in the past. This will delay the Fed’s ability to cut its policy rate next year.
The surveyed economists have become more optimistic about the chances of a soft landing, where the Fed can bring inflation down without causing excessive job losses. Over 40% of the economists believe that it is somewhat likely that inflation can be brought back to 2% without the unemployment rate exceeding 5%. Another quarter of the respondents consider it about as likely as not. When asked about the timing of the next recession, many economists pushed back their estimates further into the future compared to their previous predictions.
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