Fed already started a two-day meeting on Tuesday, with economists expecting central bank to announce a third consecutive quarter of hike (announce a third consecutive three-quarter point rate hike).
"This is really going into the realm of restrictive monetary policy. We will go into the no-man's land," said an economist. “We have not actually tightened policies to combat inflation since the early 1980s.” There may be any surprises in the Fed’s quarterly forecast of inflation, the economy and interest rates.
When the Fed ended its two-day meeting on Wednesday afternoon (early morning of Thursday morning Beijing time), the most important thing is not what the Fed does, but what it says can do in the future (its forecast may matter most) . The Fed's forecast is always important, but this time it's more important because investors have been trying to raise interest rates to and how much impact their actions will have on the economy.
The Fed is expected to fire off another three-quarter point rate hike — its third in a row. It will also release quarterly forecasts for inflation, the economy and future interest rate paths on Wednesday at 2 p.m. ET (2 a.m. Beijing time on Thursday). Federal Reserve Chairman Jerome Powell will hold a press conference at 2:30 to deliver a speech. He is expected to stress that the central bank will do everything it can to fight inflation and is unlikely to reverse rate hikes anytime soon. "I think he put up a bulletin board behind him that says ' inflation must fall'," said Rick Rieder, BlackRock chief investment officer for global fixed income. "I think he will speak tough." The new forecasts also appear as the central bank enters the rate hike range, with some economists expecting the rate hike range to be stricter and may have a more serious impact on the economy.
"It's not what they do, it's what they say. This is our first actual austerity roadmap. So far, we have a theoretical roadmap, but from the Fed's perspective, they're entering a world of austerity. It's a big deal," said Diane Swonk, chief economist at KPMG.
The Fed has raised interest rates for seven months and will now raise its target interest rate to a level considered neutral when inflation is low. Neutrality is considered a rate level where Fed policies are no longer loose but not yet restrictive. The Fed believes that 2.5% is neutral, and if it raises three-quarters, the federal funds rate will be between 3% and 3.25%.
"This is really going into the realm of restrictive monetary policy. We're going into the no-man's land," Swank said. "Since the early 1980s, we have not actually tightened policies to combat inflation. Their goal is to slow down long term, allowing inflation to fall slowly, and only gradually increase unemployment. Whether they can get there is another question."
Rate expectations jumped
Economists have been raising their expectations of how high the Fed sets the federal funds target before stopping rate hikes. This level is called terminal rate.
After an unexpectedly hot sale in August, expectations for the Fed's tightening policy have increased dramatically over the past week. Final interest rates for federal funds futures priced through April Monday were 4.5%, up from around 4% before the inflation report was released last Tuesday.
htmlCPI rose 0.1% in November, while economists had previously expected a decline.
"Last week's CPI data had a big impact on market repricing," said Peter Boockvar, chief investment officer at Bleakley Advisory Group. Stocks have been selling since the report, bond yields soared, and some short-term treasury bonds yields rose above 4%. The 10-year Treasury yield rose to 3.59% on Tuesday, its highest level since April 2011.
The latest forecast from the Federal Reserve in June estimates that the final interest rate for federal funds in 2023 is 3.8%.
Economists now expect the Fed to raise its final interest rate forecast to more than 4%. Economists at Citigroup said that if the Fed needs to become more active in the inflation struggle, they can even see inflation exceeding 5%.
Goldman Sachs economists said in a report that they expect Fed officials’ median forecasts will show fund rates at 4% to 4.25% at the end of the year and will be raised to a peak of 4.25% to 4.5% in 2023. Then they expect to cut production in 2024 and two more in 2025.
Labor market pain
Swonk expects the unemployment rate to jump to more than 5% by the end of next year.
htmlIn June, the Federal Reserve predicted the unemployment rate this year to be 3.7%, the same as in August. Fed officials also expect unemployment to rise to 3.9% in 2023 and to 4.1% in 2024.
"I think they'll get a little bit about the unemployment rate. I support the camp where they have to really raise the unemployment rate to really make progress on inflation," said Jim Karen, head of global fixed income macro strategy at Morgan Stanley Investment Management. "They belong to the camp of 'we don't have to do that'."
Caron said that the Fed rate hike is a process that increases the risk of recession.
"By increasing the risk of recession, you can reduce inflation risks because it's all about reducing demand in the economy," he said. "What is sacrificed is a slowdown in future growth."
Some investors bet the Fed will raise interest rates a full percentage point, but most economists expect a 75 basis point hike. One basis point is equal to 0.01 percentage points.
"I think 75 basis points are almost a piece of cake," Caron said. "Now, it's about what they actually tell us... They don't want to do forward guidance, but the reality is that people will still look at their forward guidance."
"Hawk" market ('Out-hawk'the market)
Powell's tone is more hawkish. He gave a brief and direct speech at the Fed’s annual Jackson Hall workshop in late August, warning that the economy could suffer from the Fed’s tightening policy. The chairman stressed that the Fed would use economic data to guide policies, and he also stressed that policymakers would maintain high interest rates until inflation eased. "I think this information will be roughly the same as Jackson Hall," said Michael Gapen, chief U.S. economy at Bank of America. "It will be about restrictive policies, implemented over a period of time, the overall goal is price stability."
Karen said Powell might inadvertently sound dovish because the Fed is already very hawkish.
"I think the third consecutive upward 75 basis points is pretty tough," Caron said. "I don't think they have to work very hard on the 'hawkish' market."
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