Bloomberg: Fed’s message contradicts market expectations of rates cuts in 2023

12 December 2022 217
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Source: Bloomberg

Authors: Craig Torres and Liz McCormick

Article: Original article

Publication date: Sunday, December 11, 2022

After the fastest monetary policy tightening since the 1980s, it seems that the Fed is intended to raise the rate by 0.5% on Wednesday after four consecutive hikes of 0.75%.

This move would raise rates to the 4.25-4.5% range, the highest level since 2007. According to economists surveyed by Bloomberg, the Fed might also signal another hike of 0.5% next year, and once rates peak, they will remain the same till the end of 2023.

Financial markets agree with the Fed’s short-term vision, but expect rate cuts by the end of next year. It might be related to investors’ expectations that price pressures will weaken faster than the Fed believes. It also might show their bets on the growing unemployment as a bigger issue for the Fed.

For the last 5 rate cycles, the average hold on a peak rate was 11 months, and those were periods of more stable inflation.

Conrad DeQuadros, senior economic adviser at Brean Capital LLC, said that the Fed pushes the idea that the rate is likely to hold at its peak for some time. The market hasn't gotten this message yet. The estimates of the decrease in inflation are too bright, according to his opinion.

Another point of view stands that supply constraints will keep inflation high, as redesigned supply lines and geopolitics affect essential resources from chips and workforce to oil and other commodities.

Therefore, central banks will cautiously react to the progress of inflation, which may only be temporary and vulnerable to causing other problems. 

At present, swaps traders expect the Fed’s rate to reach slightly lower than 5% between May and June, with a 25-basis-point decline around November, and the rate of about 4.5% at the end of 2023.

The Fed’s rate path projected by the market would mark a surprisingly fast win over inflation, which is currently exceeding three times the target level of 2%.

Fed’s officials haven’t completely excluded the possibility of a quick slowdown in inflation. John Williams, the New York Fed president, expects the inflation rate to reduce twice by the end of 2023, or nearly to 3-3.5%. 

Investors are also quite optimistic on price pressures. Inflation swaps and Treasury Inflation Protected Securities predict a sharp fall in the pace of consumer price growth next year.

At the same time, there are signs showing that the road back to the Fed’s target of 2% might be long and hard.

Over the past three months, employers added jobs at a pace of 272,000 per month. It’s slower than the average of 374,000 over the previous quarter, but still steadily above pre-pandemic levels.

Fed’s officials noted that inflation has a quality to take root, therefore, it takes a lot of time to get it out of the millions of pricing decisions which businesses and households make every day.

They also estimate the reaching of their aim as securing inflation at the level of 2%, not 3%, and may not want to start lowering borrowing costs if inflation gets stuck above this target level.

For instance, Williams said that he doesn’t expect the benchmark lending rate to fall until 2024, although he expects inflation rates to drop next year. 

Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group, said that people are prone to expect something that has already happened before. It’s something that they usually underestimate. 

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This content is for informational purposes only and is not intended to be investing advice.

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