For the fourth meeting in a row on Nov 2, the US Federal Reserve Open Market Committee (FOMC) raised its target rate by another 75 basis points (bps) to the 3.75% to 4.00% range.
While some analysts believe the pace of rate hikes may start to slow — as the Fed has guided – most believe the Fed fund rate will still exceed the current policy rate range, with markets now expecting the rate to cross 5% next year — the highest level since 2008.
OCBC Bank’s executive director of investment strategy Vasu Menon says that US Fed Chairman Jerome Powell showed “strong determination” that rates must increase further given the continued strength of the labour market and inflation data, and warned that the ultimate level of the Fed funds rate may be higher than previously expected.
In response, Menon says markets are now expecting the Fed funds rate to rise to above 5% next year from the current 4%. “Before yesterday’s policy meeting, markets were looking at a lower ceiling of just under 5% for the Fed funds rate. In addition, markets are now looking at the Fed keep its rates elevated for a longer period in 2023 before cutting rates in 2024,” he explains in a commentary dated Nov 3.
“The Fed’s decision to hike rates by another super-sized 75bps was unanimous. This clearly highlights that Fed officials are still worried about inflation even though some of them have talked about slowing down the pace of rate hikes recently,” adds Menon.
Meanwhile, Sonia Meskin, head of US macro from the global economics and investment analysis team at BNY Mellon says the emphasis on ongoing increases is “hawkish language”, consistent with at least several more hikes beyond the current policy rate range of 3.75% to 4.00%.
She believes the only meaningful difference in verbal guidance from the November meeting statement, as compared to September, was that the FOMC “anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time” and that “in determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.
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The way she reads it, references to “cumulative tightening” and “monetary policy lags” indicate the Committee’s preparedness to take growth concerns into greater consideration as policy rate exceeds estimates of “neutral”.
She adds: “In the press conference following the meeting, Chair Powell referenced his past pronouncements with respect to slowing the pace of hikes ‘at some point’, but claimed no decision has been made as of yet on the future pace of rate increases.”
However, Bill Papadakis, macro strategist at Lombard Odier believes the takeaway from the latest Fed meeting is that the US central bank is poised to start slowing the pace of monetary tightening, in what he is describing as a “shift in emphasis”, not a Fed pivot.
“The pace may slow as early as next month, even before inflation shows further signs of declining. We therefore expect a rate hike of 50bps in December, followed by 25bps hikes in both February and March, and we can’t rule out more tightening into May,” he says.
For David Kohl, chief economist at Julius Baer, he says that following the meeting, he continues to expect the Fed to hike rates by a slower pace of 50bps at its next meeting in December and see an increasing risk that the Fed will continue hiking rates in 2023, “severely overtightening” monetary policy.
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“Slowing economic activity in interest-rate-sensitive sectors like construction and softer consumer credit dynamics, as well as the sharp tightening of overall financial conditions, remain secondary for the Fed,” says Kohl.
“Despite the overall hawkish outlook for monetary policy, the pace of rate hikes is most likely to slow, as Powell suggested a slower pace of hikes at either the next or after-next FOMC meeting,” he adds.
Meanwhile, Lombard Odier’s Papadakis points out that a slower rate tightening does not mean that interest rates will peak at a lower level. “On the contrary, while the pace of monetary tightening is likely to ease, we expect the terminal rate to reach 5%, instead of 4.75% previously,” he adds.
According to him, a “strong positive” is that slower tightening leaves the Fed enough time to assess the effects of higher borrowing costs on the real economy, thus reducing the risk of a “major policy mistake”.
In its Global Insight Weekly published Nov 4, RBC Wealth Management (RBC WM) says the Fed now "stands alone". "As global central banks approach the end-game phase of aggressive 2022 policy tightening campaigns, many have taken the first steps in signalling a more cautious approach to rate hikes ahead — except the Fed," it says.
It notes that the UK's Bank of England (BoE) has taken a different tack by stating that if policy rates did indeed rise as high as markets had been expecting — north of 5% in 2023 — a two-year long recession could be the result. "Though the BoE delivered a 75bps rate hike, it has set a firmly dovish tone, with the pound falling nearly two percent against the dollar in the aftermath of its meeting. That puts dollar strength — which has already caused global stress — back on the radar as the Fed now stands alone," says RBC WM.
It adds the Fed still has "no real sense" of what that its terminal level will be: "The risk is only growing that the Fed is going to simply keep at it until something breaks, and that higher rates will mean a faster policy reversal as prospects of a 'hard landing' for the economy grow."
