According to reports, investors remain hopeful that the Federal Reserve will raise benchmark interest rates at a lower rate than the previous one at Wednesday's Federal Open Market Committee (FOMC) meeting. Chicago Mercantile Exchange’s federal funds' futures showed 80 percent of investors believed in a half of a percentage point hike.
The Fed’s monetary tightening cycle began in March this year, with the central bank raising the interest rate in every FOMC meeting since then — by 75 basis points in each of the last four meetings. Currently, the benchmark rate is in the 3.75 to 4.0 percent range.
The central bank increases the interest rates to bring down inflation, partially caused by the disruption in the global supply chain and high consumer demand. The Fed aims to lower inflation to two percent, but analysts have expressed concerns that the economy will go into recession before the central bank hits that target.
Currently, the inflation indicators that the Fed uses still show conflicting signs of an inflation slowdown. The November producer price index (PPI) released on Friday showed a year-to-year increase of 7.4 percent, against an initial forecast of 7.2 percent. Despite that, the rate was lower than October’s PPI, which hit eight percent.
The real estate market has shown signs of slowing down due to the tight monetary policy, with mortgage rates increasing, resulting in a significant decrease in demand. On the other hand, the job market in the U.S. stays resilient, although data has shown an increase in unemployment benefit claims. Since wages are still growing, consumer spending remains high.
On Tuesday, the government will publish the November consumer price index (CPI), which will provide more insights into market pricing. October’s CPI showed a 7.7 percent increase compared to last year.
Projection for 2023
Schwab Center for Financial Research head of fixed income strategy Kathy Jones said inflation had come down in the U.S. but not “as quickly as people want it to.”
Agreeing with a 50 basis points hike in the upcoming meeting, Jones said that the Fed might consider raising the interest rate by 25 basis points at the beginning of 2023. However, she added that the Fed was likely “making it up as they go along” at this point.
In addition to announcing an interest rate hike, the Fed will release a gross domestic product (GDP) forecast for 2023. It projected a 1.2 percent GDP growth in 2023 and an increase in the unemployment rate by 4.4 percent at the end of Q3. The central bank also predicted that personal consumption expenditures would increase by 2.8 percent.
Analysts said the Fed would likely cut its GDP projection and increase the expectations for the unemployment rate and consumer prices. The Fed is also expected not to trim the interest rate until the beginning of 2024. Analysts concluded that it might be “too late” for the Fed to prevent a recession.
“A pivot or pause is not a cure-all for this market,” Truist Advisory Services co-chief investment officer Keith Lerner said. “Rate cuts may be too late. Recession risks are still relatively high.”
Meanwhile, Comgest Global Investors CEO Arnaud Cosserat warned people that they should start to worry about disinflation in the next two years. In this scenario, the disinflation will likely be caused by a decline in demand and negative GDP growth. If the situation continues for a while, the market can enter a deflation.
"Everybody has been talking about inflation this year. Going forward, it will be more about disinflation in 2023 or 2024,"
Arnaud Cosserat, Comgest Global Investors CEO
Cosserat suggested investors look for consumer companies that maintain pricing power and profit margins. He specifically mentioned luxury goods producer Hermes and cosmetics mega-company L’Oreal as resilient companies in this economic situation.