Recent economic news and the Fed

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Credit Sesame discusses recent economic news and what it means for the upcoming Fed meeting.

At the end of November 2023, the U.S. Bureau of Economic Analysis (BEA) released two positive reports on key aspects of the economy. One signaled strong growth, the other easing inflation. Given that the Federal Reserve has spent the better part of the past two years walking a tightrope between bringing inflation down and not plunging the economy into a recession, this double dose of good news should be just what the doctor ordered.

Now that things are going its way, how will this affect the Fed’s interest rate policy at its upcoming meeting and beyond? A closer look at recent developments sheds some light on the Fed’s options.

Growth even stronger than originally thought in 3rd quarter

The first piece of good economic news from the BEA was that economic growth was more substantial than initially thought in the 3rd quarter of 2023.

On November 29, the BEA released a revised Gross Domestic Product (GDP) estimate showing the economy grew at an inflation-adjusted annual rate of 5.2%. This was even better than the original estimate of 4.9%, which already was considered a very strong number.

5.2% was the economy’s strongest quarter of growth since 2021 when the economy was still bouncing back from the pandemic. It was more than twice the growth rate of either of the first two quarters of this year.

This growth must have been reassuring to the Fed. Members of the Federal Open Market Committee (FOMC), the sub-group of the Fed that makes interest rate decisions, are well aware that raising interest rates to calm inflation risked snuffing out economic growth. They were willing to take this risk because, in the long run, inflation tends to be even more harmful than a recession.

Still, relatively weak employment reports for June and then again for October must have given FOMC members some nervous moments. The only silver lining was that these job numbers were affected by labor actions that have since been resolved. However, the recent GDP report confirms that the economy still has momentum.

Inflation is easing

The other good news is that the Fed seems to be making clear progress in its fight against inflation.

The Personal Consumption Expenditures (PCE) price index is the FOMC’s preferred measure of inflation. While similar to the more widely followed Consumer Price Index (CPI), the PCE price index is more responsive to changes in consumer buying habits. This helps capture how consumers tend to shy away from goods and services whose prices are rising the most in favor of more reasonably priced options.

On November 30, the BEA announced that the PCE price index rose by less than 0.1% in October 2023 and was up by just 3.0% for the past 12 months. That was a clear improvement to the 3.4% increase for the 12 months ending in September 2023. These numbers echo the previously released CPI figures for October, which showed no increase in average monthly prices and a 3.2% increase over the prior 12 months.

To put this into the context of the Fed’s interest rate policy, the FOMC’s goal is to get inflation down to 2.0%. While inflation is not there yet, it is getting quite close and heading in the right direction.

How does this economic news affect the Fed’s thinking?

The FOMC is due to meet on December 12 and 13, and the latest GDP and inflation numbers leave them with various options.

One way to look at this is that the Fed could stand pat and see if inflation continues to ease. Unless inflation perks up again, the FOMC may not find it necessary to take the risk of another rate hike.

On the other hand, the latest growth numbers suggest the economy is resilient enough to withstand another mild rate hike. The more hawkish members of the FOMC may feel it’s worth finishing the job of reining in inflation while growth conditions are favorable.

The bottom line is that recent economic trends put the Fed in the position of dealing from strength. Neither inflation nor the threat of recession is so urgent right now that it demands immediate action.

Don’t write off the possibility of one more rate hike

Recognizing that inflation has been the economy’s biggest problem over the past few years, investors have greeted recent signs of slowing inflation with great enthusiasm.

Last month, the Dow Jones Industrials Average soared by nearly 490 points on the day of the CPI news release and by 520 points on the day of the PCE price index release. There seems to be a consensus that the Fed won’t raise rates at its next meeting, and there’s already a lot of talk about when the Fed will start cutting rates.

However, it may be too soon to assume the Fed is done raising rates. After all, the most recent set of economic projections by the FOMC shows the Fed anticipates making one more rate hike this year. While the Fed could stand pat at its next meeting, don’t be surprised if they follow through on their plans for a quarter-point rate increase. They may well decide that the prudent thing to do is err on the side of trying to finish off inflation.

Other options for the Fed

If the Fed doesn’t follow through on its original plans for another rate hike, what other options does it have?

One argument for standing pat is that bond yields have risen enough to do some of the job of Fed rate hikes. Bond investors are as wary about inflation as the Fed. Following the Fed’s last rate hike, 10-year Treasury bond yields were up by about half a percent through the end of November. Like Fed rates, bond yields impact borrowing costs. The Fed may view the rise in bond yields as sufficient to suppress inflationary overspending.

Another option is that the Fed could stand pat on rates but signal that it will wait longer before cutting rates next year. The FOMC is due to release an updated set of economic projections at its upcoming meeting. Laying out a cautious rate path for last year could discourage investors and businesses from getting too optimistic about inflation conditions.

The Fed is dealing from strength for the first time since inflation flared up in 2021. However, it is unlikely to become complacent about inflation any time soon.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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