This week the focus in the US is on the Fed meeting and the inflation data for November. The Federal Reserve will decide tomorrow what the next interest rate move in the country will be. Market consensus expects the US central bank to raise rates by 50 basis points at its last meeting in 2022, putting it in a range of 4.25% – 4.50%.
To learn more about the expectations ahead of the Federal Open Market Committee meeting, here are comments from Allianz Global Investors, AXA IM, Carmignac, DWS, Federated Hermes Limited, Generali Investments, Muzinich & Co. and CRM UBS AM Iberia.
Franck Dixmier, Global Fixed Income Chief Investment Officer, Allianz GI
In the US, inflation seems to have peaked, as shown by the recent October indicators, with the consumer price index (CPI) at 7.7% (compared with a June peak of 9%) and core CPI at 6.3% (September peak at 6.6%). Furthermore, core PCE, which peaked in March at 5.33%, fell to 4.9% in September (peak in March at 5.33%). However, the inflation story does not seem to be over, as wages continue to accelerate: +0.6% month-on-month in November (against +0.3% expected and +0.4% in October) and +5.1% over 1 year.
Despite an increasingly restrictive policy mix, the US economy continues to accumulate good news. Its resilience can be seen in services, with the ISM Service index rising sharply in November (56.5 against 53.3 expected and 54.4 in October) and, more surprisingly, through the rise in industrial orders, despite the weakness observed in the ISM Manufacturing index. It can be seen above all in the health of the job market, which continues to surprise. November’s data confirmed its resilience, with job creation up again (+263k against +260k expected and +284 in October), an unemployment rate of 3.7% and an increase in the ISM employment sub-component (51.5 against 49.1 in October). US companies seem reluctant to let go of employees they have struggled to recruit.
In this context, the US Federal Reserve will have to continue to slow down the US economy. After 4 rate hikes of 75bp, Jerome Powell should certainly recalibrate the amplitude of the hikes, and we expect a 50bp increase at the next FOMC meeting on December 13 and 14. But this does not prejudge the number of hikes to come to reach the terminal rate.
Gilles Moëc, chief economist at AXA IM
The Fed is not ready to land. It is currently circling around the airstrip, trying to see through a “data fog” if conditions are getting met before fully deploying the landing gear. It seems to us that the Fed now has good reasons to believe that the quantum of tightening it has already delivered this year is having an impact on inflationary
pressure, but also that the gap relative to its target is still too high to warrant complacency. We thus expect the slowdown to 50 bps to be accompanied by plenty of hawkish noises, both in terms of qualitative comments as well as in the main takeaways from the new forecasts. While the Fed has for now refrained from emulating the Bank of England – which we also expect to hike by 50 bps this week – in directly commenting and contradicting market expectations, we think the recent market rally is being met by quite some frustration at the FOMC. Indeed, if broad financial conditions continue to loosen, impairing the transmission of the policy tightening, the chances to see inflation landing relatively quickly will diminish. Powell may be tempted to shake the market out of its current complacency. This could make for a still “rhetorically hawkish” Wednesday night.
Kevin Thozet, member of the Investment Committee at Carmignac
This week a 50 basis points rate hike is expected. And given the Fed’s well publicized path to a terminal rate of 5%, we’re unlikely to see any major surprises for the first meetings of 2023 especially with Mr. Powell moving away from prioritizing spot inflation to a focus on the longer 2% inflation objective. As such, for now, monetary policy has been somewhat reduced for the first part of 2023: it took seven months to move from 0.5% to 4%; it will take three months to bring them to 5%.
Beyond this is where things get interesting. If and when the Fed will pivot is the key question on investors’ minds, especially in light of Powell’s increasingly dovish tone.
We see three potential scenarios:
- The materialization of a hard landing for the US economy leading to a rapid turn towards easing.
- A soft landing would see interest cuts later than many anticipate.
- Sticky inflation meaning rates stay at terminal level for longer before moving even further into restrictive territory.
Christian Scherrmann, U.S. Economist at DWS
Following an array of Fed talk, a shift down to 50 basis point rate hikes, from 75 basis points before, seems to be the most likely outcome of the upcoming December 13-14 FOMC meeting. This, however, should not be seen as the Fed shifting towards a more dovish monetary policy stance. Inflation remains far too high, labor markets too strong and supply and demand too imbalanced for the Fed to relax its guard. Inflation does show some early signs of easing but the tight labor markets, above all, remain a big headache for the Fed. There are still 1.6 job vacancies for every person unemployed, meaning the demand for labor remains strong, and wages are increasing by more than 5 percent per year. This, unfortunately, is far from being an encouraging configuration for the economy.
The Fed is eager to tame inflation while doing the least possible harm to the economy and society, but the fight will have its costs. We expect the Fed’s updated Summary of Economic Projections in the December meeting to reflect these costs as well as the willingness to accept lower growth and higher interest rates in 2023. The Fed’s dot-plot will likely show, in our view, a peak rate of slightly above 5.0 percent while growth for next year might be downgraded to less than 0.5 percent – just short of predicting recession.
Sticking with a hawkish stance in the face of a mild downturn might serve several purposes. If interest rates remain elevated through 2023 it might ensure that inflation remains low in subsequent years. Therefore, only in 2024 will FOMC members likely indicate their expectations of policy normalization. At that point interest rate cuts will most likely be pencilled and growth forecasts will be raised a little, though they will likely remain below potential. A “hawkish pause” in 2023 might furthermore keep financial conditions tight and contractionary – another prerequisite to get the inflation job done.
Investors should therefore not get too excited about smaller hikes in the upcoming meeting. They do not indicate that the Fed is going to begin easing policy to help growth or that the Fed is returning to the so-called ‘Fed put’— its old tendency to support markets. That, above all, might prove to be a relic from the low inflation times.
Silvia Dall’Angelo, economista senior en Federated Hermes Limited
The Federal Reserve will likely increase rates by 50 basis points to a 4.25-4.5% range next week, justifying a slightly slower hiking pace with the need to start to assess the impact on the real economy from the large cumulative tightening that has taken place since March of this year.
However, the Fed will stress that it is still far from mission accomplished with respect to its fight to high inflation and more hikes will follow in coming months. Our expectation is that while inflation will decline over 2023, it will remain above target, which will prevent the Fed from easing next year.
Paolo Zanghieri, senior economist at Generali Investments
On Wednesday, anything different from a 50bps rise in the Fed funds rate would be a huge surprise. The main focus will be on how further the Fed will tighten and for how long it plans to keep rates at the current very restrictive level. We expect for 2023 two more 25 bps rises, which will bring the policy rate to the 4.75%-5% range. FOMC members have reiterated their pledge to keep rates at peak at least until early 2024, but this commitment will be heavily tested by the worsening in the economic conditions.
We expect US GDP to grow by just 0.3% next year, and it will contract in Q2 and Q3. Given this outlook the Fed’s forecast of an unemployment rate of just 4.4% at the end of 2023 looks too rosy: something above 5% looks more likely., Therefore, in order to avoid too hard a landing of the economy, the Fed will be forced to cut rates earlier than it currently plans, and we project a 50 bps reduction in the final months of next year. Risks are tilted to a more hawkish stance: without convincing evidence of inflation declining fast, the Fed may be pushed to raise the policy rate above 5% and keep it for longer, which will worsen the outlook for the economy.
Erick Muller – Director, Product and Investment Strategy, Muzinich & Co.
We believe that the Federal Reserve meeting next week (14 th December) will come with critical information regarding the US interest path for 2023.
As we look towards 2023 it seems clear that it is a question of when, rather than if, the US enters a recession. In recent weeks, many commentators have been suggesting that the prospect of a soft landing in the US remains a possibility, however we don’t believe this will be the likely scenario that plays out.
Similarly, there are some within the Fed that seem keen to capitalise on last week’s stronger than expected US employment figures, and potentially raise rates to as high as 6%, but again we believe the Fed will be a bit more nuanced than this in its approach next week.
Jaime Raga, senior CRM UBS AM Iberia
The Fed’s tightening of financial conditions has meant some progress in slowing aggregate labor income, cooling the housing market and bringing down goods consumption. But the service spending dynamics mentioned above are unique to this COVID-19-driven cycle and arguably tougher to break. We believe this means the US economy (and earnings) probably don’t fall off as sharply as many are projecting, and, however, also the Fed will need to keep rates higher for longer.
In the meantime, China is signaling the relaxation of zero-COVID-19 measures, even in the face of elevated case counts. In our view, this suggests a commitment to such a shift in policy, which should allow for a boost in consumption. The process is unlikely to play out in a straight line, but the direction of travel seems pretty clear, to us. Our confidence that the bottom is in for China is fortified since these adjustments to COVID-19 policy are taking place in tandem with the most comprehensive support for the property sector to date. A rebounding China may provide a needed boost as developed economies slow, but will also likely lead to higher commodity prices. This too may make it difficult for the Fed and other central banks to back off too quickly.
