Don’t hold your breath for lower interest rates

The Federal Reserve does a decent job telegraphing where interest rates are heading. Last week’s decision to leave rates unchanged was no exception.

But four times a year — in March, June, September, and December — the central bank’s rate action is paired with an update to its economic projections. The latest forecast surprised more than a few Fed watchers, rattled financial markets, and dimmed hopes for a quick reprieve from high borrowing costs.

What happened: Fed officials upgraded their outlook, saying economic growth would be stronger and unemployment lower than they thought in June. That was good news.

On the downside, they reiterated their intention to boost the benchmark federal funds lending rate one more time this year in a bid to ensure that inflation continues to cool.

Moreover, policy makers indicated they would keep borrowing costs elevated throughout 2024. If that forecast holds, rates on credit card balances, mortgages, and auto loans would remain well above where they were before the pandemic.

The reaction: Wall Street had expected the Fed to ease rates in the first half of next year. Some forecasters still see that happening.

But investors registered disappointment that Fed chairman Jerome Powell repeated the central bank’s “higher for longer” rate mantra in a press conference following Wednesday’s decision. His comments, and the Fed’s projections, suggested that interest rates may need to be steeper in coming years than in the past to meet the central bank’s twin mandate of low inflation and maximum employment.

The Standard & Poor’s 500 index fell 2.9 percent for the week to its lowest close since early June. The yield on the bellwether 10-year Treasury bumped up to 4.43 percent, the highest since 2007.

The numbers: The median estimate among Fed officials has the economy expanding by 2.1 percent this year, more than double the June projection. And they see unemployment holding at the August rate of 3.8 percent for the rest of the year, and rising only modestly to 4.1 percent in 2024.

Policy makers also were a bit more optimistic about inflation this year — shaving the estimate for their preferred measure to 3.7 percent, which would be down from July’s rate of 4.2 percent. But they still expect inflation to exceed their 2 percent target in 2024 and 2025.

With the economy picking up speed and inflation running above target, the Fed said the federal funds rate could end the year above the current range of 5.25 percent to 5.5 percent. Policy makers raised their forecasts for 2024 and 2025 by a half percentage point, to 5.1 percent and 3.9 percent, respectively.

What it all adds up to: The Fed sees the descent to 2 percent inflation taking until 2026.

As The Wall Street Journal’s Greg Ip wrote last week, the Fed’s same projections hint that “rates might be higher not just for longer, but forever.” After paying down debt following the financial crisis, households and businesses have a strong appetite for borrowing, Ip said, and large government deficits are putting upward pressure on rates.

In other words, super-cheap money — 30-year mortgage rates under 3 percent, 4-year auto loans under 5 percent — may be a thing of the past, absent a recession.

Parting thoughts: As always, caveats abound.

The Fed’s forecasting track record is mixed at best.

As a group, private economists don’t see the economy growing as quickly as the central bank does. The chances of a recession are 60 percent, according to a Bloomberg survey of forecasters. And the consensus outlook is that rate cuts will come faster than the Fed outlined as growth falters and unemployment climbs.

Finally, there are wild cards to consider: the widening auto workers strike, the potential for a US government shutdown, a renewed rise in oil prices, and the resumption of student loan repayments. To varying degrees, each could act as a brake on the economy.

Asked about these risks last week, Powell emphasized the uncertainties they present, but then he added, “Ultimately, you’re coming into this with an economy that appears to have significant momentum.”

How long that momentum continues is anyone’s guess.