Strategist who loves challenging consensus sticks by call for 8% fed-funds rate

nine December 2022

U.s.a. Federal Reserve preview: trapped between a stone and a difficult place

A 50bp hike is widely expected given loftier inflation and a tight jobs market, merely the market is pricing in a recession, and falling Treasury yields and a weakening dollar are undermining the Fed’s efforts to dampen price pressures. A hawkish Fed message will probable fall on deafened ears unless the data start proving the central bank right

In this article

  • A step down to a college peak
  • Signalling could autumn on deaf ears
  • Inflation makes things tricky
  • five% in the first quarter merely rate cuts from the third
  • Market rates have dropped similar a stone – time for the Fed to sell bonds?
  • FX markets: Short-end rates hold the key for the dollar


Expected Federal Reserve interest rate hike

A step downward to a higher peak

A 50bp hike at the xiv Dec Federal Open Market Committee (FOMC) meeting is the potent telephone call from both financial markets and economists. Afterwards implementing 375bp of rate hikes since March, including consecutive 75bp moves at the previous 4 meetings, Federal Reserve officials are of the view that they’ve fabricated “substantial progress” on tightening policy so it is time to “step down” to lower increments. Nonetheless, Fed Chair Jerome Powell and the team have been at pains to signal out that despite smaller individual steps, the “ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting”.

Scenarios for the xiv December FOMC meeting

Source: ING

Signalling could autumn on deaf ears

In this regard, the Fed will be concerned past the recent steep falls in Treasury yields and the dollar, coupled with a narrowing of credit spreads, which are loosening financial atmospheric condition – the verbal opposite of what the Fed wants to encounter as information technology battles to become inflation lower.

These moves were themselves triggered by a weak core CPI print for October that came in at 0.three% calendar month-on-month versus a 0.5% consensus expectation, while the Fed’south favoured measure out of inflation – the core personal consumer expenditure deflator – was even softer, rising only 0.2%. The market reaction seems excessive to u.s.a. given this is just one month of data, annual core inflation is even so running at triple the target, and to hitting 2% year-on-year the calendar month-on-month readings need to average 0.17% over time – and we aren’t at that place notwithstanding. The Federal Reserve will need to meet several months of core aggrandizement readings of 0.i% or 0.two% to be confident that inflation is on its style back to target and this is likely to be a primal plank of its messaging.

With that in heed, nosotros think the Fed is not finished with its rate hikes and its new forecasts will indeed indicate a higher path for the Fed funds rate to five% with potential slight upward revisions to nigh-term Gross domestic product, and persistently loftier inflation forecasts used to justify this. Certainly, the consumer sector has been holding upwards improve than many – including ourselves – expected, with strong jobs and income gains supporting spending.

ING’s expectation for what the Fed will predict

Source: ING, Federal Reserve
ING, Federal Reserve

Looking further ahead, several officials such every bit James Bullard and John Williams accept suggested the Fed may not be in a position to cut involvement rates until 2024, and we doubtable Powell and the forecasts will echo this sentiment. However, we strongly suspect that this is more tied to the Fed trying to go longer-dated Treasury yields higher rather than a conviction call that recession and lower inflation over the medium-term will exist avoided.

Inflation makes things tricky

Now, information technology is important to remember nosotros get November inflation on 13 December – the day earlier the FOMC coming together – and the outcome volition exist of import for what the Fed has to say. If core CPI comes in at or above the 0.3%MoM consensus forecast, its messaging as outlined above will probably prevail. If inflation is softer and yields tumble further then the Fed may take to be more forceful and perhaps raise the possibility of accelerating a run-downwards in the size of its residue canvas via reduced reinvestment of gain from maturing assets. The cardinal bank volition stick with the hawkish messaging until it is confident inflation is browbeaten.

5% in the showtime quarter simply rate cuts from the third

In terms of our view, we look for a concluding 50bp hike in February, taking the Fed funds ceiling to 5%. But like the market, we think a recession volition dampen price pressures and the composition of the Usa inflation basket, which is heavily weighted to shelter and vehicles, volition facilitate a far faster drop in annual inflation readings than elsewhere. Remember too that the Fed has a dual mandate which includes an employment dynamic. This offers the Fed greater flexibility versus other central banks to respond with stimulus and we believe information technology will from the third quarter of 2023 onwards.

Market rates have dropped like a stone – fourth dimension for the Fed to sell bonds?

If the Fed wants to re-tighten financial conditions by plenty, information technology needs to engineer a hawkish hike. Longer dates, in the wake of the recent falls in yields, are trading as if the Fed is done post the Dec hike. Bold the Fed is not done, the first quarter of 2023 should sustain a rising rates theme to it. That should force yields back up, commencing a dis-inversion procedure on a bend that is now heavily inverted. We’ve likely seen the peak in market place rates, but that does non prevent marketplace rates from moving higher, at least for every bit long as the Fed is still hiking and the cease-game is not fully clear.

The Fed has non said too much virtually the circumstances on the coin markets. We notwithstanding have in excess of $2tr going back to the Fed on the reverse repo facility, reflecting an excess of liquidity in the arrangement. This in plough is driven there every bit a analogue to the volume of bonds notwithstanding sitting on the Fed’south balance canvas. The Fed is rolling off some $95tr per calendar month, but there is always the option to do more, or more pertinently to sell bonds back to the market outright. While it may be a tad premature to suggest this, it’due south an choice should the Fed actually want to encounter longer-dated market rates revert higher.

FX markets: Brusk-finish rates concord the central for the dollar

Dollar cost activeness over the last two months has been very poor. The dollar has tended to sell off sharply on signs of softer price data but has struggled to rally on any positives – such as the November United states jobs reports. That price activeness suggests a market place caught long dollars at college levels after a five-quarter dollar rally. The hope for dollar bulls now is that positioning is much better balanced afterwards an 8% drop in the merchandise-weighted dollar and a 12% drib in USD/JPY.

Preventing an even sharper dollar sell-off has probably been the view that the Fed volition continue to hike into 2023. The terminal rate is yet priced not far from v% and merely 50bp of rate cuts are priced in the second half of 2023. Every bit long as the FOMC statement, Dot Plots, and printing conference practise not generate any more dovish pricing – and that seems unlikely – we doubtfulness the dollar has to sell off much further.

Our baseline view would run into EUR/USD holding around the 1.05 area every bit the Fed validates the current pricing of its trajectory in money markets. A more than dovish turn would exist a surprise and with seasonals confronting the dollar in December, EUR/USD could spike above resistance at i.06 towards the 1.07 area in thin yr-cease markets.

Our multi-week preference, however, is that the Fed is still going to talk tough, and heading into January the dollar starts to make a improvement – where four.v%+ deposit rates wait increasingly attractive amid a global slowdown.


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