Fed sees aggressive hike to 5%, triggering global recession

Fed sees aggressive hike to 5%, triggering global recession

(Bloomberg) – Federal Reserve officials will maintain their staunchly hawkish stance next week, laying the groundwork for interest rates to hit 5% by March 2023, moves that appear likely to lead to a U.S. recession and world, said economists surveyed by Bloomberg.

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The Federal Open Market Committee will raise rates by 75 basis points for a fourth consecutive meeting when policymakers announce their decision at 2 p.m. in Washington on Wednesday, according to the survey.

Officials had additional reason to stay the course when U.S. government data showed on Friday that employment costs were rising at a healthy pace in the third quarter and the central bank’s preferred inflation gauge was still on. well above its 2% target.

According to the survey, rates are expected to rise another half point in December and then a quarter point at the following two meetings. Fed forecasts released at the September meeting showed rates hitting 4.4% this year and 4.6% next year, ahead of cuts in 2024.

Economists see the Fed determined not to pivot too soon as it battles inflation at its highest level in 40 years. The move to a higher peak rate would reflect growth in consumer prices, excluding food and energy, which have been warmer than expected over the past two months. The survey of 40 economists was conducted October 21-26.

“Inflationary pressures remain intense and the Fed is expected to hike 75 basis points in November,” said James Knightley, chief international economist at ING Groep NV, in a survey response. “We currently expect a more moderate hike of 50 basis points in December given a weakened economic and market backdrop,” but risks are skewed towards a fifth hike of 75 basis points, he said.

Fed Chairman Jerome Powell said the central bank was firmly committed to restoring price stability and he repeatedly invoked his predecessor, Paul Volcker, who raised rates to record highs to counter the inflation in the early 1980s. Powell warned that the process would be painful, as the goal is to create below-trend growth to reduce price pressures and unemployment will rise accordingly.

Powell and his colleagues have not given up hope of achieving a soft landing for the economy. But for the first time in surveys ahead of the FOMC meeting, a majority of economists – three-quarters – see a recession as likely within the next two years, and most of the rest see a hard landing with a period of zero. or negative growth ahead.

What Bloomberg Economics says…

“I think the most important thing to watch is how Powell communicates the potential slowing in the pace of rate hikes. He will want to avoid giving the impression that a pivot is imminent, especially when underlying inflation is clearly still strong. It would set the markets up for a 50 basis point rise in December but that would also come with a dot plot, which shows a terminal rate of 5%.”

— Anna Wong, Chief U.S. Economist

Economists see the Fed as potentially too tight: the median economist would set a maximum target rate at 4.75%, and 75% of economists said there was a greater risk of the central bank raising rates too much and causes unnecessary pain rather than not doing so. increase sufficiently and not contain inflation.

“The monetary policy lags are still underestimated,” said Thomas Costerg, senior US economist at Pictet Wealth Management. “The full effect of the current tightening may not be felt until mid-2023. By then it may be too late. The risk of policy error is high.

There could also be economic fallout in global markets, as two-thirds expect a global recession in the next two years.

While the median of economists expects a 50 basis point increase in December, it’s a close call, with nearly a third penciled in a 75 basis point hike.

The rate trajectory expected by economists is similar to that forecast by the markets. Investors fully expect a 75 basis point hike on Wednesday, lean towards a 50 basis point hike in December and expect rates to peak around 4.8%.

If the Fed makes another 75 basis point move next week, the combined 375 basis point increase since March would represent the Fed’s biggest rate hike since the 1980s, when Volcker was president and battled a skyrocketing inflation.

“With the Fed faced with the choice of doing too much or too little, members are likely to choose to do too much,” said Joel Naroff, chairman of Naroff Economics LLC, in a bid to head off inflation persistence. Volcker has faced ever since. the 1970s.

Economists expect the Fed to continue its announced reductions in its balance sheet, which began last June with the runoff of maturing securities. The Fed is reducing its assets by up to $1.1 trillion a year. Economists project to raise the balance sheet to $8.5 trillion by the end of the year, falling to $6.7 trillion in December 2024.

There is narrow divergence on whether the Fed will move to selling mortgage-backed securities as part of the cuts, with 57% expecting that move and no consensus yet.

The FOMC statement is expected to retain its language giving interest rate guidance that promises continued increases, with no specifics on the size of the adjustments, although a quarter are looking for softer language signaling smaller increases.

Nearly a third of economists expect dissent at the meeting, which would be the third in 2022. Kansas City Fed President Esther George dissented in June in favor of a higher hike. modest, warning that too abrupt changes in interest rates could undermine the Fed’s ability to achieve its expected rate path. St. Louis Fed President James Bullard dissented in March as a hawk.

Beyond slowing rate hikes, economists see the Fed possibly reversing course in response to weaker growth and inflation. Most see a small first rate cut in the second half of 2023, with larger cuts in 2024.

(Updates with Employment Cost Index and PCE data in third paragraph.)

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