The Fed Was Wrong For 2 Years: Two Data Points Say They'll Be Wrong On Rates In 2023

The Federal Reserve on Wednesday conceded its two-year error in inflation forecasting. This followed data issued by the Bureau of Labor Statistics showing the lowest inflation since March 2021, prompting the Fed to issue a "hawkish pause" on interest rates.

“Fed forecasts have been wrong on inflation for the last two years,” said Fed Chair Jerome Powell during a press conference.

Wednesday’s decision to halt raising rates marked the first pause in a tightening cycle that began in March 2022. But the Fed’s sobering self-assessment leaves market watchers wondering — will predictions for 2023 fare any better?

Ryan Detrick, chief market strategist at Carson Group, and Robin Brooks, chief economist at the Institute of International Finance, seemed skeptical.

Brooks criticized the Fed’s upward revision of the 2023 Q4/Q4 core PCE forecast from 3.6% to 3.9% in a tweet, saying it implied an overly pessimistic view for the second half of 2023 with a steady 0.3% m/m run-rate until the year ends.

Meanwhile, Detrick pointed to a disparity between the Fed and the market, tweeting, “So 12 of 18 Fed members see two hikes left in ’23. Yet, ‘the market’ is saying less than a 7% chance of two hikes in ’23.”

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So, is it a lack of trust given the Fed’s history or simply the result of following lagging data, as Jeffrey Gundlach suggested on CNBC?

Gundlach’s sentiments suggested a disconnect within the Fed. Describing the recent rate decision as a “hawkish pause,” he pointed to inconsistencies between the Fed’s rhetoric and action and questioned whether the central bank is overlooking high-frequency data.

"It’s interesting to notice that two years ago, the forecast for the fed funds rate at the end of 2023 was 50 to 75 basis points — so they missed by 450 basis points and even more if they continue to hike, which I don’t think they’re going to do," Gundlach said.

Gundlach noted there are "so many" indicators that are deeply in recessionary territory, despite the strength of the labor market.

He highlighted a subtlety in the jobs data, suggesting that investors are missing the bigger picture, pointing out that while we've seen an uptick in job numbers, it’s the average hours worked that provides a more accurate snapshot of the labor market and overall economic output.

Gundlach explained his logic: multiply the number of jobs by the average hours worked, and you land on a figure that more accurately represents economic output. It’s true, jobs have increased, but growth is offset by a meaningful reduction in the average hours worked.

In Gundlach’s assessment, if the average hours worked remained consistent, the picture would be less rosy. The decline in hours was substantial enough that, keeping all else constant, we would have seen job losses — more than 100,000 jobs to be precise.

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