The Fed is preparing to reduce the pace of rate hikes to 50 basis points at its December 13-14 meeting. We think that the Fed will increase the fed funds rates to the 4.25% – 4.5% band as a consensus. Stronger-than-expected activity data comes first among the factors that will underpin hawkish expectations. Most activity data since the previous meeting surprised positively. In particular, supply-demand adjustment in the labor market was slower than the Fed expected.
Inflation has slumped further since the last FOMC meeting on easing supply constraints and the Chinese-induced decline in global commodity prices. A series of weak inflation readings, including the October CPI and import price reports, boosted confidence among policymakers that price increases have already peaked. Further, it is necessary to understand whether a number of key factors that allow downshifting are related to the Fed’s policy actions. One of them is that Covid cases in China limit oil demand as a phenomenon that alleviates inflation. This was instrumental in lowering prices.
The counter-factual will be a re-emerging pressure on oil prices and resilient demand keeping core inflation alive. There are important details for the Fed’s risk-weighting, and it looks like the terminal rate expectations will be revised upwards, although the pace of rate hike will slow down. The key topic of discussion at the FOMC meeting may be the economy’s resilience to faster rate hikes than policy makers expected. Concerns about stronger underlying inflation will prompt several policymakers to raise their final rate estimates and the media to point to a 5% cap.
Index of Concern: Probability of Quarterly Downfall in Quarterly Real GDP, 1970:Q4 – 2023:Q4… Source: Federal Reserve Bank of Philadelphia, Bloomberg
Compared to the Summary of Economic Forecasts released in September, there are a few titles that will change. Unemployment rate revisions will likely occur in different directions for the short and longer run. Tight labor market data put us on a November unemployment rate of 3.7%, the forecast for this year can be expected to hold steady at 3.8% or be revised down to the current level. However, we expect an upward revision in the unemployment rate indicators from 2023, which is an adjustment that should be made in the context of reflecting the effect of the Fed’s rate hikes in the data. Estimates in September had projected 4.4% for 2023 and 2024 and 4.3% for 2025.
Inflation, on the other hand, will be slightly more cautious in terms of lower layers despite the recent easing. The slow decline in inflation in basic services will be influential in these forecasts. Therefore, an upward revision of PCE and core PCE is possible. In September, 5.4% PCE and 4.5% core PCE were predicted for the short-term outlook encompassing 2023. In PCE, the 2024 expectation is 2.3% and the 2025 expectation is 2%. It can be expected that these will remain the same, in line with the federal funds rate forecast, which will ensure that inflation will decline in line with the Fed’s targets.
The median estimate for terminal funds rates will rise from the September projections. The median will likely come to somewhere near 5%, down from 4.6% in September. This is where complete consensus will not occur, because although the median indicates 5%, some points will show the final ratio somewhere above 5%. Not all members agree on the terminal interest rate and how long (through 2023) it should stay at these levels. Participants can predict the higher path for federal funds rates. We would expect interest rates to be restrictive enough to bring inflation closer to the 2% price target in 2024.
In summary; Powell will emphasize that the decision to slow down rate hikes does not mean that the committee has given up on the fight against inflation. We think that the plan to slow the pace of rate hikes depends on the perspective of giving policymakers space to assess the effects of cumulative tightening and approaching the natural level of interest rates. The Fed will also need to point out that its work is not done and will indicate that rates will remain high for a while. We can expect Powell to strike a similar balance to his November 30 speech. If the long-term perspective we have mentioned is brought forward, this will of course correspond to a hawkish attitude.
Kaynak: Tera Yatırım-Enver Erkan
