Fed hikes rates by 50 bps, keeps rate target intact

Fed hikes rates by 50 bps
Fed hikes rates by 50 bps

Indian Market
by 5paisa Research Team Last Updated: 2022-12-15T17:05:29+05:30

At the last FOMC meeting of 2022, Jerome Powell hiked rates by 50 bps after the Fed had previously hiked rates by 75 bps each in four consecutive meetings. With the latest 50 bps rate hike, Fed rates have scaled up to the range of 4.25% to 4.50%. It may be recollected that since March 2022, Fed had already hiked rates by 425 basis points. One cryptic statement coming from the Fed statement is that the terminal rates could still be much higher than anticipated and is now pegged in the range of 5.00%-5.25%, with a likely median peak rate of 5.1%.

What is the outlook for rates in year 2023?

Here is a quick look at the CME Fedwatch probabilities that are implied in the futures trading prices. Between March 2022 and December 2022, the Fed rates have risen from the range of 0.00%-0.25% to the range of 4.25%-4.50%. The CME Fedwatch estimates the probabilities of future rate hikes based on the probability implied in the Fed trading prices. Here are the implied Fed rate scenarios over next 8 meetings, with focus on the cluster where the rate move is most likely.

Fed Meet

450-475

475-500

500-525

525-550

Feb-23

75.0%

25.0%

Nil

Nil

Mar-23

28.5%

56.0%

15.5%

Nil

May-23

20.6%

48.3%

26.8%

4.3%

Jun-23

22.0%

47.3%

25.6%

4.1%

Jul-23

27.0%

43.0%

21.4%

3.3%

Sep-23

33.1%

34.8%

14.5%

2.0%

Nov-23

34.1%

22.4%

6.9%

0.8%

Dec-23

25.3%

10.8%

2.36%

0.2%

Data source: CME Fedwatch

What do we infer from the above table? Clearly, lower inflation has opened the doors for the Fed to hike another 3 rounds of 25 bps each and that could be all in 2023 as of now, although things could change in a disruptive scenario. Here are some key takeaways.

  • Despite the rate hike intensity reduction from 75 bps to 50 bps it looks like there could be 3 more rate hikes in 2023 of 25 basis points each. That is likely to take the terminal rates to the range of 5.00% to 5.25%.
     

  • What has made the outlook slightly more dovish? In the latest US consumer inflation announcement for November 2022, food inflation and core inflation are lower, but still relatively high by historical standards. Fall is too much about energy alone.
     

  • Even in 2023, Fed is expected to front load 75 bps of rate hikes in the first 3 meetings of 2023, so the peak rates should be reached by May 2023. That gives give enough leeway to the Fed to take corrective action and even cut rates if warranted.


 

Key insights emerging from the Fed statement

The message is almost doubled edged. On the one hand, the Fed has indicated that it is done with its ultra-hawkish stance. On the other hand, the message is also that it would not relent till the inflation came down decisively to 2% levels. Here are key takeaways.

  1. Fed chairman has underlined a terminal rate of around 5.10% to be touched in first half of 2023. With neutral rates at 2.5%, current Fed rate is already 200 bps above the neutral rate; sufficient to push inflation down rapidly.
     

  2. As per the CME Fedwatch, the market is also factoring in the possibility of rate cuts in the second half of 2023, if the negative impact on growth is too apparent. Remember, this is already the highest rate in the last 15 years.
     

  3. The dot plot chart indicates that 17 of the 19 members pegged Fed rates at above 5% in 2023. The projection for 2024, as per dot plot chart, is Fed rates almost 100 bps lower at 4.1% levels.
     

  4. The Fed is not in favour of any premature loosening of policy since empirical evidence is against such a move. One inflation warning is that core inflation target has been raised 30 bps to 4.8%, which means inflation could be sticky for much longer.
     

  5. What about the hard landing. Now, the Fed chair is confident that it can be avoided. That confidence, apparently, stems from the turnaround in the GDP growth to positive territory in the third quarter, after 2 quarters of negative GDP growth in 2022.

 

What is the message for the RBI from the Fed statement?

First and foremost, for India it is growth above all else; even above inflation control. That is something India cannot compromise for too long, especially if the idea is to bulldoze the global markets with 7% growth in the next few years. RBI is now reconciled to abstaining from rate hikes in its February MPC meet, irrespective of FOMC outcome. Fed confidence will only encourage RBI to reduce its accent on inflation and increase focus on growth. In India, the CPI and WPI inflation are clearly pointing to falling inflation.

The moral of the story is that the RBI was extremely quick and fleet-footed to turn hawkish. Now it has to diverge its thoughts from the Fed and refocus on growth. That will be the big challenge for the RBI to implement in 2023.


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