Fed Seen Aggressively Rises to 5%, Triggers Global Recession

(Bloomberg) — Federal Reserve officials will maintain their resolutely hawkish stance next week, laying the groundwork for interest rates to reach 5% by March 2023, moves that appear likely to lead to a U.S. and global recession, economists surveyed by Bloomberg said.

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The Federal Open Market Committee will raise interest rates by 75 basis points for a fourth consecutive meeting when policymakers announce their decision at 2 pm in Washington on Wednesday, the survey found.

Officials were given further reason to stay the course when US government data on Friday showed employment costs rose at a steady pace in the third quarter and the central bank̵[ads1]7;s preferred gauge of inflation remained well above its 2% target.

Prices are estimated in the survey to rise by a further half a point in December, then by a quarter of a point in the following two meetings. Fed forecasts released at the September meeting showed interest rates reaching 4.4% this year and 4.6% next year, before cuts in 2024.

Economists see the Fed as determined not to swing too early as it battles a 40-year inflation rate. The shift to a higher top rate will reflect growth in consumer prices, excluding food and energy, which came in warmer than expected in the past two months. The survey of 40 economists was carried out on 21-26 October.

“Inflationary pressures remain intense and the Fed is set to hike by 75 basis points in November,” James Knightley, chief international economist at ING Groep NV, said in a survey response. “We currently forecast a more subdued 50 basis point increase in December given a weakened economic and market backdrop, but risks are skewed towards a fifth 75 basis point increase,” he said.

Fed chief Jerome Powell has said the central bank is strongly committed to restoring price stability, and he has repeatedly invoked his predecessor, Paul Volcker, who raised interest rates to unprecedented levels to counter inflation in the early 1980s. Powell has warned that the process will be painful, because the goal is to develop below-trend growth to reduce price pressures and unemployment will rise as a result.

Powell and his colleagues have not given up hope that they can get a soft landing for the economy. But for the first time in the pre-FOMC meeting surveys, a majority of economists — three-quarters — see a recession as likely in the next two years, and most of the rest see a hard landing with a period of zero or negative growth ahead .

What Bloomberg Economics Says…

“I think the most important thing to watch for is how Powell communicates the potential slowdown in the pace of rate hikes. He will avoid giving the impression that a pivot is imminent, especially when core inflation is clearly still strong. He would prepare markets for a rise of 50 basis points in December, but which will also be accompanied by a dot plot, showing the 5% terminal rate.

— Anna Wong, Chief Economist in the United States

Economists see the Fed as potentially overtightening: The median economist wants to set a top target of 4.75%, and 75% of economists said there is a greater risk that the central bank will raise rates too much and cause unnecessary pain as opposed to not. increases enough and fails to contain inflation.

“Monetary policy lags remain underestimated,” said Thomas Costerg, senior US economist at Pictet Wealth Management. “The full effect of current austerity may not be felt until mid-2023. By then it may be too late. The risk of a policy error is high.”

There could also be economic spillovers to global markets, as two-thirds expect a global recession in the next two years.

While the median of economists is looking for a 50 basis point increase in December, it’s a close match, with nearly a third looking for a 75 basis point increase.

The interest rate path that economists expect is similar to that predicted by the markets. Investors fully expect a 75 basis point hike on Wednesday, are leaning toward a 50 basis point hike in December and are looking for rates to peak around 4.8%.

If the Fed delivers another 75 basis points next week, the total increase of 375 basis points since March would represent the steepest increase in Fed rates since the 1980s when Volcker was chairman and was battling skyrocketing inflation.

“When the Fed is faced with the choice of either doing too much or too little, its members are likely to choose to do too much,” said Joel Naroff, president of Naroff Economics LLC, aiming to avoid the persistent inflation Volcker faced from the 1970s.

Economists expect the Fed to continue its announced balance sheet reductions, which began in June with the outflow of maturing securities. The Fed is reducing assets by up to $1.1 trillion a year. Economists project that will bring the balance to $8.5 trillion by the end of the year, falling to $6.7 trillion in December 2024.

There is a tight split on whether the Fed will move to sell mortgage-backed securities as part of the tapering, with 57% expecting the move and no consensus on timing.

The FOMC statement is expected to retain its language that provides guidance on interest rates promising ongoing increases, without specifics on the size of the adjustments, although a quarter are looking for softer language signaling smaller increases.

Nearly a third of economists expect a dissent at the meeting, which will be the third in 2022. Kansas City Fed President Esther George ruled out in June in favor of a smaller hike, warning that too sudden changes in interest rates could undermine the ability of the Fed to reach its planned interest rate trajectory. St. Louis Fed President James Bullard dissented in March like a hawk.

Beyond slowing interest rate increases, economists see the Fed eventually reversing course in response to lower growth and inflation. Most see a small reduction in the first rate in 2023’s second half, with larger cuts in 2024.

(Updates with employment cost index and PCE data in the third paragraph.)

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