By Jigar Trivedi
The Federal Reserve met expectations and hiked rates by 75 bps. With inflation proving to be far stickier than imagined, the Fed repeated that activity needs to slow much more with the door left wide open for a fourth consecutive 75 bps hike in November. With recession looking virtually impossible to avoid, we see a strong chance of policy reversal later in 2023. The Federal Reserve has hiked the Fed funds target range by 75 bps in what was a unanimous decision and upped its forecasts for rate hikes aggressively.
Year-end 2022 Fed funds is now expected at 4.4%, above the 4.2% rate implied by futures contracts ahead of this update, signalling the strong likelihood of another 75 bps in November with a further 50 bps or possibly even a fifth consecutive 75 bps hike on the cards at the December Federal Open Market Committee meeting. It is important to note that there is a strong clustering within the dot-plots, showing all FOMC members are on board with this more hawkish narrative.
A very hawkish Fed
More tightening is signalled for 2023 with the year-end rate at 4.6%, before it moves lower to 3.9% for 2024, 2.9% in 2025 with the longer run prediction remaining at 2.5%. To underscore the Fed’s willingness to sacrifice growth to get inflation lower it has cut 4Q 2022 year-on-year GDP growth to 0.2% from 1.7% with 2023 cut to 1.2% from 1.7%. The Fed is effectively acknowledging that a recession is coming, but inflation will not fall quickly and there will be a lot of pain. Note the unemployment rate for next year is expected to reach 4.4% versus the current 3.7% and stay there through 2024 with only a very minor drop in 2025.
Federal Reserve forecasts September versus previous June predictions
Another 75 bps hike in November with 50 bps minimum in December
Inflation has been stickier than the Federal Reserve expected and certainly more broad-based. To get it down the economy needs to run below potential, bringing demand into better balance with supply capacity. The only way the Fed can do that is to hike rates and keep policy restrictive until that is achieved. Given the Fed’s aggressive stance and the likelihood that inflation moves little over the next month while job creation remains firm, we expect the Fed to hike 75bp for a fourth consecutive time at the November 2nd FOMC meeting. Come December FOMC meeting, we are more hopeful that we will see clearer signs of moderating price pressure on the lead indicators, but we are also fearing weaker activity data that may be enough to convince the Fed to move more cautiously. 50 bps is our call, which would leave the target range at 4.25-4.5%, but we certainly can’t dismiss the possibility of a fifth 75 bps hike.
In the scenario mentioned above, the dollar index is likely to travel to 113 / 114 levels in sessions to come and the USDINR may hit levels above 81.5 a dollar unless the RBI intervenes. The Reserve Bank of India will hold its monetary policy on 30th September (next Friday) which needs to be closely watched for now. Any further escalation in the geo-political risk between Russia and Ukraine may push energy prices, eventually hurting the rupee. The outlook is bullish in the USDINR but we don’t deny technical correction, still….it could be used for going long.
(Jigar Trivedi, Senior Analyst – Currency & Commodity, Reliance Securities. Views expressed are the author’s own.)