Commentary by Thomas Costerg, US economist at Pictet Wealth Management, with his predictions on the Fed meeting on Wednesday 1 February.
The Federal Reserve looks likely to raise rates by 25bps on 1st February, representing a downshift in the pace of rate hikes after +50bp in December and +75bp in November. The main likely explanation for this downshift will be the slowdown in recent inflation readings, which may make the Fed less anxious about the inflation situation. There are also signs of slowing private consumption, especially around the Christmas period, suggesting that “demand” is now moving back better in line with “supply”. The Fed is also likely to indicate it takes into account the long lags in monetary policy, after very steep rate hikes in 2022.
Importantly, the Fed is fixated on the US labour market, and will likely still be worried that it remains too tight, leading to potentially resilient wages feeding into services inflation. In particular, JOLTS job openings are still too elevated in the Fed’s view, especially versus the number of unemployed. This is the reason we think the Fed is very unlikely to signal that the Fed is about to pause rate hikes soon. It’s still too early to signal that a rate-hike stop is just around the corner, we think. The Fed, we think, still probably intends to keep pushing rates above 5% in the near future, in line with the December dot plot (which showed a terminal rate of 5.1% this year).
A key uncertainty going into the meeting will be how Powell judges the evolution of financial conditions. The main hawkish risk in this meeting is that Powell expresses his uneasiness with the recent loosening in financial conditions, and the sharp run-up in equity prices so far this year. Powell insisted on the transmission of US monetary policy via financial markets at the December meeting.
Our view is that the Fed will keep hiking interest rates at 25bps increments and that the fed funds rate will indeed settle slightly above 5% by May 2023; then the Fed will pause and keep rates stable until year’s end. The Fed is likely to push back against current market pricing of rate cuts from July. The bar to cut rates is high in our view, and would probably necessitate several months showing net job losses, which looks unlikely before early 2024. At this stage, the Fed is more worried about an inflation re-acceleration rather than about sharp disinflation due to an economic recession. The main risk nevertheless is that the Fed may have underestimated policy lags, and that 2023’s growth could be curbed more than anticipated by the 2022’s sharp monetary tightening. The risk of policy mistake remains high.
