The Federal Reserve raised its fed funds rate for the first time since 1994 by 75bps to 1.50-1.75% to tame inflation and Chairman Powell said another rate hike of either 50bps or 75bps was likely at the next Fed meeting in July.
The Federal Open Market Committee (FOMC) also forecasts the fed funds rate would now end 2022 at 3.25-3.50% and projected further rises to 3.75-4.00% in 2023. This in line with our own view that the fed funds rate will need to reach at least 4% now to lower headline inflation from 8.6% in May back towards the central bank’s 2% target.
Despite the Fed’s first 75bps rate hike in almost three decades, the S&P 500 rallied and the safe-haven USD and US Treasury yields fell after Chairman Powell said ‘clearly, today’s 75 basis point increase is an unusually large one and I do not expect moves of this size to be common.’ The new FOMC forecasts also project core inflation will fall towards the Fed’s 2% goal - without causing a recession - from an estimated 4.3% rate at the end of this year to 2.7% in 2023 and 2.3% in 2024. The FOMC cut its GDP forecasts but still projects growth at 1.7% this year and next and only sees unemployment rising modestly from 3.6% currently to 3.7% this year and 3.9% in 2023.
But we think the risks are still skewed towards the Fed needing to front-load its tightening this year to reduce inflation, as it did in 1994, when the Fed hiked by 50bps at every meeting of the year and 75bps at its last meeting of 1994.
Source: Bank of Singapore, Bloomberg.
The chart shows the fed funds rate at 1.50-1.75% remains below the FOMC estimate of its ‘longer-run’ or neutral level that neither stimulates nor contracts the economy. To restrict inflation, we expect the fed funds rate will need to rise to at least 4.00% now, well above neutral levels of 2.50%.
We expect the Fed will hike 75bps again in July to hit neutral levels of 2.50% for fed funds, then 50bps in September and November and 25bps in December to reach 3.50-3.75% by year end. We also see at least one 25bps hike in January to 3.75-4.00% with risks of further rises in 2023 if core inflation stays near 4%. We also lift our Treasury yield forecasts with 10Y yields reaching 4.00%. This keeps us bullish on the USD against other major currencies.
Banner image source: AFP
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