Peak rate in excess of 5%
The recent meeting of the Federal Open Market Committee (FOMC) went largely as expected. The committee raised interest rates by 50 basis points. FOMC members also provided an updated Summary of Economic Projections (SEP) as shown below. The surprise may have been that FOMC raised the projection for the peak rate in 2023 by 50 basis points to 5-5.25%. Interestingly, the median inflation projections also rose despite better recent inflation news. The market is pricing in two additional rate hikes of 25 basis points each in February and in March, resulting in a peak rate of around 5%.
In terms of macro economic data, the FOMC meeting came against a backdrop of mixed signals on final demand, labor markets and inflation. The data does not yet suggest that a hard landing is imminent. The November CPI print and retail sales reports were weaker than consensus but at the same time the labor market remains resilient.
When asked about the possibility of rate cuts next year, Powell said that the FOMC will only cut rates if it is confident that inflation is moving down in a sustained manner. Clearly they need substantially more evidence that inflation is on a downward path.
If payrolls continue to run at their recent pace, combined with upside surprises in inflation data, dialing down the hawkish rhetoric is going to be challenging. There are also favorable developments with respect to China reopening.
However, recent market events, such as private credit and real estate funds gating redemptions and a wave of bankruptcies in the crypto space, suggests to us that some market stresses are starting to emerge. It may well be that the market is struggling to come to terms with the higher cost of capital.
“As you will have seen, 19 people filled out the SEP this time, and 17 of those 19 wrote down a peak rate of 5% or more. So that’s our best assessment today for what we think the peak rate will be. You will also know that at each subsequent SEP during the course of this year we actually increased our estimate of what that peak rate will be. And today the SEP shows overwhelmingly FOMC participants believe that inflation risks are to the upside so I can’t tell you confidently that we won’t move up our estimate of the peak rate again at the next SEP. I don’t know what we’ll do. It will depend on future data.”
Figure 1. FOMC participants’ assessments of appropriate monetary policy
Source: Federal Reserve
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