Federal Reserve officials signaled a striking shift in their short-term policy expectations on Wednesday, with nine of the central bank's 19 policymakers indicating they now see an interest-rate increase as necessary this year. The views were published alongside the Fed's decision to maintain its target policy range at 3.50% to 3.75%.
The updated individual projections - often referred to as the dot plot - show that, compared with three months ago when none of the policymakers expected a rate rise this year, almost half of the committee now believes further tightening will be required. Of those nine officials, six say more than a single quarter-point hike would be appropriate before year-end.
Not all members of the committee shifted toward tighter policy. Eight policymakers remain of the view that the policy rate should be left unchanged this year, while one participant favored a single rate cut. One unnamed official did not submit any rate-path projection.
The evolution in views reflects a rapid change in the central bank's internal debate - moving from a focus on the timing and extent of potential rate cuts to a growing concern that recent increases in oil prices could broaden inflation pressures. That sharp pivot comes after an oil-price surge tied to the Iran war, which has lifted headline price measures.
Global oil prices have since fallen substantially following an agreement announced last week between Iran and the United States intended to restore flows through the Strait of Hormuz. However, the outlook for how quickly shipments and exports can return to previous levels is uncertain because energy infrastructure suffered damage during the three-month conflict. Fed officials have the option to revise their dot-plot submissions up until shortly before publication, so the released views are intended to reflect the most recent developments in the Middle East.
The Fed's projections also show forecasters have become more pessimistic about inflation since March. Based on the median policymaker view, year-end inflation as measured by the personal consumption expenditures price index is now projected at 3.6%, up from a 2.7% year-end expectation in March. The median projection for core PCE inflation - which excludes volatile food and energy prices - was raised to 3.3% from 2.7% in the prior set of projections.
Labor-market projections suggest officials see employment conditions remaining firm. The unemployment rate is now forecast to be 4.3% by year-end, matching the actual May reading and down from a 4.4% projection made in March. That revision signals increased confidence among many policymakers that the labor market is not deteriorating to a degree that would require support from interest-rate cuts.
Economic growth expectations edged lower. Gross domestic product is projected to expand 2.2% this year in the latest median outlook, down from the 2.4% growth projection released in March.
The divergence of views contained in the dot plot presents a policy challenge for the new Fed chairman, who was appointed by the president with an initial expectation of cutting rates. The greater level of support for holding or even raising rates reduces the feasibility of moving to looser policy, according to the range of individual projections.
Summary
At the Fed's latest meeting, nearly half of policymakers signaled they expect rate increases this year as oil-driven inflation pressures push projected PCE inflation higher. The Fed kept the policy rate unchanged at 3.50%-3.75%, lifted year-end inflation forecasts, maintained a relatively strong unemployment outlook, and trimmed its GDP growth forecast.
Key points
- Nine of 19 Fed policymakers now project at least one rate hike this year; six of those want more than a single quarter-point increase - sectors impacted: financial markets, banking, fixed income.
- Median PCE inflation forecasts rose to 3.6% for year-end and core PCE to 3.3%, up from 2.7% in March - sectors impacted: energy, consumer goods, and inflation-sensitive commodities.
- Unemployment is seen at 4.3% by year-end while GDP growth is downgraded to 2.2% - sectors impacted: labor-intensive industries, consumer services, and cyclical sectors.
Risks and uncertainties
- Oil market volatility following the Iran war - uncertainty about how quickly shipping and exports recover given damage to energy facilities could keep inflation elevated - sectors affected: energy, transportation, and industrials.
- The possibility that higher inflation could prompt additional rate increases - which would influence borrowing costs and financial conditions - sectors affected: banking, housing, and credit-sensitive businesses.
- Differences in policymakers' rate views create uncertainty about the Fed's eventual path - financial markets may face greater volatility as views evolve - sectors affected: fixed income, equities, and institutional asset managers.