Chair of the U.S. Federal Reserve Jerome Powell addressing the economic outlook, inflation and the labor market at the Brookings Institution, November 30, 2022 in Washington, DC. AFP.
This month the Federal Reserve (Fed) is set to lift its fed funds rate by 50 basis points (bps) to 4.25-4.50%, a step down from the rapid 75bps hikes at its last four meetings as US inflation finally starts to cool.
The Fed is likely to raise its forecasts for the peak in its interest rates to 5.00% in 2023. If its forecasts are even more hawkish, the USD and Treasury yields will rise and risk assets weaken.
The European Central Bank (ECB), Bank of England (BoE) and Swiss National Bank (SNB) are also set to hike by 50bps to 2.00%, 3.50% and 1.00% respectively.
The ECB and BoE, facing double digit inflation, may consider 75bps hikes, but rising recession risks are set to make Europe’s central banks step down to 50bps too in the week ahead.
Chair of the U.S. Federal Reserve Jerome Powell addressing the economic outlook, inflation and the labor market at the Brookings Institution, November 30, 2022 in Washington, DC. AFP.
This month, the Federal Reserve (Fed) is set to lift its fed funds rate by 50bps to 4.25-4.50%, a step down from the rapid 75bps rate hikes at its last four meetings as US inflation finally starts to cool.
Source: Bank of Singapore, Bloomberg.
As the chart above shows, the Fed’s aggressive actions this year have pushed interest rates above ‘longer-run’ neutral levels so that monetary policy is now restricting activity to lower inflation back towards the Fed’s 2% target.
The Federal Open Market Committee (FOMC) will not want to tighten monetary policy excessively and cause a major downturn in the US economy. So, Chairman Powell and other FOMC members have signalled the Fed will likely slow its pace of rate hikes now with a 50bps rise at its upcoming meeting on 13-14 December.
The FOMC, however, will also be updating its forecasts. We expect officials will increase their projections for the peak in the Fed’s rate cycle to at least 5.00% in 2023 and anticipate no rate cuts until 2024. If FOMC members give even more hawkish rate projections then the USD and US Treasury yields will jump, and risk assets will sell off. Thus, investors should be cautious ahead of the meeting with November’s consumer price index (CPI) inflation due before the Fed’s decision.
Source: Bank of Singapore, Bloomberg.
In the week ahead, we expect the European Central Bank (ECB), Bank of England (BoE) and Swiss National Bank (SNB) will also step down from 75bps rate hikes to 50bps moves. We forecast the ECB to raise its deposit rate to 2.00%, the BoE to lift its Bank Rate to 3.50% and the SNB to increase its Policy Rate to 1.00% respectively.
The ECB and BoE face inflation at 10.0% and 11.1% compared to their 2% inflation goals. Thus, some officials may be keen to stick to 75bps rate hikes. But with the Eurozone and UK likely in recession owing to the energy shock from the war in Ukraine, we expect the central banks will step down from 75bps hikes to 50bps now.
Lastly, if the ECB surprises by hiking 75bps still, we would be concerned rising financial stress in the Eurozone may force the ECB to unwind its rate hikes quickly in 2023. This is what happened – to the detriment of the EUR – after the ECB prematurely raised interest rates during the 2008 financial crisis and the 2011 Eurozone debt crisis as the second chart shows.
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