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The next FOMC meeting is on February 1, where the Federal Reserve will determine its next policy decision regarding interest rates. This article covers how the market expects the Fed to respond, what readers should be watching for changes in the expected path, and the potential second-order effects of such changes.
The current expectation is for an interest rate increase of +0.25%, with the market assigning close to 100% certainty of this outcome, pegging the policy rate at 4.5%-4.75%.
The Fed’s expected course for 2023 is to keep rates elevated, and several Fed governors recently stressed the need to keep policy rates tight enough to ensure that inflation does not return after initial signs of slowing, as it did. in the 1970s.
In Jerome Powell Press conference on December 14He said the following (emphasis added):
“So, as I mentioned, it is important that general financial conditions continue to reflect the tightening policy that we are implementing to bring inflation down to 2 percent. We believe that financial conditions have tightened significantly in the last year. But our political actions work through financial conditions. And these, in turn, affect economic activity, the labor market and inflation. So what we control is our policy moves in the communications we make. Financial conditions anticipate and react to our actions.
“I would add that our focus is not on short-term moves, but on persistent moves. And many, many things, of course, move financial conditions over time. I would say it is our judgment today that we are not yet in a tight enough policy stance, so we say we would expect continued hikes to be appropriate.”
Prices in transitory inflation
Global risk assets have been in recovery mode to start the year as market participants increasingly expect the inflationary fear that rocked financial assets in 2022 to abate in 2023 and beyond. While optimistic expectations of lowering inflation would certainly be bullish for risky assets, as it would lead to a return to lower interest rates, it would be prudent to take into account the frivolous nature of the Federal Reserve’s inflation forecasts, as shown below. . A return to the 2% target is almost always the expectation.
With inflation declining and policy rates staying high, the market believes “sufficiently tight” policy will manifest in 2023, with cuts of 1.31% in 2024.
Once inflation takes root in consumer expectations and labor markets, history has shown that it takes a monumental effort by central banks to tighten policy rates in order to squash inflation.
as pointed out Liz Ann’s Specials From Charles Schwab, the 6-month change in inflation expectations is the largest since 2011, an indication that monetary tightening has begun to make its way into the real economy.
With a 25 basis point rate hike almost confirmed tomorrow, the market will pay close attention to the content and tone of Chairman Powell’s speech regarding the future path of key interest rates. We believe that “longer high” is a tone that the Fed will continue to communicate to the market.
However, on a long enough timeline, the inevitable outcome is clear. Ask the US Treasury for their projections…
Font: United States Treasury
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