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Markets are poised for the upcoming rate decision and policy statement from the US central bank, with this being the last rate decision of the year 2022.
Despite the strong November Jobs Report and ISM Services, market seems convinced that Fed will deliver a 50-basis point hike this week.
This is largely because Federal Reserve Chair Jerome Powell said last week at a speech at the Brookings Institution. Powell also said, “The time for moderating the pace of rate increases may come as soon as the December meeting”.
Additionally, the FED could also see the movements of financial markets as being positive. Stock markets have started to ease and alongside bond yields.
The reality is that the recent easing in financial conditions is premature, and further hikes will be needed. It is still reasonable to expect Fed to reach a terminal rate of 5.00-5.25% in March.
The FED still needs to close the positive output gap to bring inflation down, but with ISM business activity at the highest level since December 2021 and labour supply stagnating since last March, further tightening will still be needed.
A larger hike seems unlikely, however, I expect a hawkish message regarding the policy stance in 2023. This is because CPI is still extremely high in the United States and globally.
The Federal Reserve will need to see several months of core inflation readings of 0.1% or 0.2% to be confident that inflation is on its way back to target, and this is likely to be a key plank of its messaging.
I think the Fed is not finished with its rate hikes and its new forecasts will indeed indicate a higher path for the Fed funds rate above 5%, with only slight upward revisions to near-term GDP.
Energy prices have only recently dropped and global supply disruptions remains, and China is only just starting the initial stages of coming out of lockdown now.
