Financial basis

The Fed will take rates higher than expected; more pain to come

By Indradip Ghosh

BENGALURU (Reuters) – The Federal Reserve will raise its key interest rate to a much higher high than expected two weeks ago and risks are skewed towards an even higher terminal rate, according to economists polled by Reuters.

The change in expectations came after the Fed raised rates by 75 basis points last week for the third consecutive meeting and planned to go higher than previously thought to tame inflation, which is four times greater than the target.

Since then, already battered global equities have sunk much deeper into bear market territory – a drop of 20% or more – on recession fears and most currencies have weakened further against the multi-decade high dollar. .

But that’s unlikely to cause the Fed to change its policy course anytime soon, as Fed Chairman Jerome Powell and other policymakers have remained candid about the “pain” ahead.

Indeed, more than 70% of economists, 59 out of 83, predicted the central bank would hike its federal funds rate by three-quarters of a percentage point for the fourth straight meeting in November, according to a Reuters poll taken after the November meeting. the Fed last week.

The survey predicted this would be followed by 50 basis points in December to end the year at 4.25%-4.50%.

If realized, it would be the highest rate since the start of 2008, before the worst of the global financial crisis, and 75 basis points higher than the 3.50% to 3.75% predicted ago. barely two weeks. The forecast is in line with the Fed’s point projection and current market prices.

“With inflation this high, history says you have to tackle it sooner and you have to follow through. The real policy error is not getting inflation down to 2%,” said Michael Gapen, economist in American chief at BofA Securities.

“If a short-term recession and a bigger increase in the unemployment rate than they expect is needed to bring down inflation, that’s not a policy mistake in their minds.”

A poll earlier this month put the probability of a recession in the United States in the coming year at 45%, with the probability of a recession occurring in the next two years at 55. %.

NEUTRAL LEVEL

A majority, 45 out of 83 economists, predicted that the fed funds rate would peak at 4.50%-4.75% or higher in the first quarter of 2023, identical to the dot plot projection and above the estimated neutral level of 2 .4% that neither stimulates nor restricts economic activity.

All but two of the 51 economists who answered an additional question said risks were skewed toward a higher terminal rate than they currently expected.

“The Fed has reinforced its commitment to whatever it takes to get inflation under control, even if it means causing pain in the economy,” said Justin Weidner, a US economist at Deutsche Bank, who expects until the rate peaks at 4.75%-5.00%.

“The short-term pain of recession would be better than the long-term pain of inflation expectations becoming unanchored.”

Additionally, unlike most major central banks, the Fed enjoys the support of a strong currency and a relatively strong economy relative to its peers.

Among economists who had a view to the end of 2023, only 46% forecast at least one rate cut.

With inflation not expected to fall below the central bank’s target anytime soon and the unemployment rate, currently at 3.7%, expected to rise at a much slower pace than in previous recessions, a premature reduction could hurt the Fed’s credibility.

More than 80% of respondents said that once the fed funds rate peaks, the central bank is more likely to leave it unchanged for an extended period rather than cut it quickly.

Rates were expected to remain in restrictive territory until at least 2026.

“To bring it (inflation) down, the economy needs to operate below potential, better balancing demand with supply capacity,” said James Knightley, chief international economist at ING.

“The only way the Fed can do that is to raise rates and keep policy tight until that happens.”

(For more stories from the Reuters Global Economic Survey:)

(Reporting by Indradip Ghosh; Additional reporting by Prerana Bhat, Polling by Milounee Purohit, Susobhan Sarkar and Aditi Verma; Editing by Ross Finley and Ed Osmond)