The Fed's Latest Projections: What it Means for Long-Term Investors

At its September meeting, the Federal Open Markets Committee kept rates unchanged with a target range of 5.25% to 5.50%, in a decision that was widely anticipated by investors. Still, markets responded negatively with bond yields jumping to levels not seen since 2007, the S&P 500 falling a couple percentage points, and tech stocks retreating further from their recent peaks. This reaction may come as no surprise to investors since disagreements around the direction of the economy and Fed policy have driven market swings all year. In addition, issues such as a possible government shutdown, cracks in China's economy, student loan payments, higher oil prices, and more, are worrying investors. As we approach the final quarter of the year, how can investors maintain perspective on the state of the economy and its impact on markets?

Markets have rallied this year due to factors such as better-than-expected economic growth, improving inflation, and a more stable financial sector. It's important to remember that today's environment is not only far better than most investors had hoped for just a year ago, but exceeds many of the rosiest projections by Wall Street analysts. Despite this, the central question that still divides investors is whether the Fed will make a policy mistake, which in this case could involve keeping rates too high for too long. This is because the Fed has maintained a "hawkish" posture as it combats inflation, utilizing not only higher interest rates, but a shrinking balance sheet and firm forward guidance.

The term "forward guidance" refers to the expectations that the Fed sets through its communications. These communications have evolved significantly over the past three decades. During the Greenspan era of the mid-1980s to mid-2000s, Fed decisions were typically made with simple written statements, often only a few short paragraphs. Beginning in 2011 under Ben Bernanke, the Fed began holding quarterly press conferences and publishing its Summary of Economic Projections "to present the Federal Open Market Committee's current economic projections and to provide additional context for the FOMC's policy decisions." During Janet Yellen's tenure, further changes were made to expand the Fed's forward guidance and provide more clarity on the expected path of rates.

Today, under Jerome Powell, the Fed Chair now hosts a press conference after every meeting, even when there is no change in the fed funds rate. This is in addition to the numerous other speeches and written pieces by the Fed Chair and other Fed officials. The Fed's use of forward guidance means that rate decisions are often telegraphed well in advance, resulting in few surprises. Thus, the market's reaction is often more in response to the press conference and the Summary of Economic Projections.

The Fed's latest projections show that it expects to raise rates one more time in 2023, with only two meetings to go. While markets are somewhat skeptical, there is a higher probability of this occurring in December based on fed funds futures. The Fed also revised its forecasts to reflect a much stronger economy, with expected GDP growth this year shifting from 1.0% to 2.1%, and the unemployment rate falling from 4.1% to 3.8%. Perhaps most importantly for market expectations, the FOMC's estimate of future policy rates jumped as well in response to these stronger economic conditions. Rather than the fed funds rate falling to 4.6% and 3.4% by the end of 2024 and 2025, respectively, the committee now believes rates will stay higher at 5.1% and 3.9%.