Inflation battle: Higher rates to restore price stability
The Federal Open Market Committee (FOMC) will in our opinion hike rates for a third time by 75 basis points (bps) at its 20-21 September meeting. It will release its new set of economic forecasts (lower growth, higher unemployment) and rate projections extending through 2025. We expect the new dot plot to indicate a higher Fed funds rate, above 4% for this year.
Please find below what we expect:
- We expect the FOMC to hike rates by 75 bps to a range of 3.00%-3.25%. We do not expect a 100 bps move despite the very strong August Consumer Price Index.
- We expect Chair Powell to reiterate that the Fed’s primary focus remains bringing inflation down to its 2% objective. He is unlikely to provide any indication about the terminal rates. The Fed needs to pursue rate hiking into restrictive territory despite the negative impact on the economy. The labor market is too tight with a risk of a wage-price spiral.
- We expect Mr. Powell to reaffirm that future policy rate decisions will continue to depend on incoming data and the economic outlook. He will no doubt remind markets that “history cautions strongly against prematurely loosening policy”.
- We expect the FOMC’s median dot for this year to move up from 3.375% to 4.125%, which reflects a 100 bps hike between the September meeting and year-end. The committee wants to mitigate risks of un-anchoring inflation expectations. For 2023, we expect to see the median dot up to 4.375% (early in 2023). The median rate projection will be at 3.625% in 2024 and at 2.875% in 2025. We do not expect a change in the terminal rate at 2.5%.
- We expect the Summary of Economic Projections (SEP) to indicate lower growth in 2022 and 2023 from 1.7% to 1% and from 1.7% to 1.3% respectively. For 2024 and 2025, we expect growth to stay close to the potential growth at around 1.8%.
- We expect the committee to revise its forecast for higher inflation figures (Personal Consumption Expenditure, PCE) with projections moving up from 5.2% to 5.4% in 2022 and from 2.6% to 2.7% in 2023. We expect median inflation expectations to be unchanged in 2024 at 2.2%, followed by decline in 2025 to 2.0%.
- Chair Powell will likely confirm the doubling of the pace of quantitative tightening in September to $95bn/month as described in May ($60bn in Treasuries and $35bn in Mortgaged-backed securities).
In summary, we expect FED Chair Powell to reaffirm the Fed’s hawkish message. This meeting will in our opinion push interest rates higher and flatten the US yield curve.
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