In view of the next meeting of the Fed’s Monetary Policy Committee, one or more officials might privately expect a recession.
Comments from Fed officials heading into the September FOMC meeting were pretty clear: interest rates need to be higher and stay that way for some time to effectively fight inflation. Some members of the FOMC committee have even openly declared their preference for key rates of 4% or more by the end of the year. Achieving this as quickly as possible – a priority on which policymakers also seem to agree – would in itself require another larger-than-usual hike of 75 basis points at the September meeting. But, on top of that, the data released since the last meeting has been surprisingly hawkish.
The August CPI, which excludes volatile energy and food prices, rose on higher housing costs. And wage increases have not slowed, despite a slight rise in the unemployment rate. There is room for action on both of these indicators through monetary policy and a 75 basis point hike at the September meeting, and should therefore be seen as the minimum the Fed can do. Indeed, shortly following the somewhat shocking rise in CPI rates, markets began pricing in even larger interest rate hikes.
At the time of writing, traders estimate the probability of a 100 basis point hike as a one in three chance. We agree that for the September meeting, the risk is on the upside. But central bankers have also signaled they are prepared to make less than 75 basis points – provided incoming data is favourable. With data still supportive, a 75 basis point hike, rather than a full 1% rise, remains the most likely outcome.
But the magnitude of the rate hike is just one thing to watch next week. The update of the economic forecast report is also expected. We expect policymakers to now signal a maximum Fed Funds rate close to or even slightly above 4% by the end of 2022. And the first planned rate cuts will likely not be indicated until 2024, when the Inflation forecasts will converge towards the 2% target.
Along with their intention to tighten monetary policy more aggressively, we expect central bankers to forecast somewhat weaker growth and somewhat higher inflation in 2023. The distribution of growth forecasts for 2023 will also be telling. One or more Fed officials might privately expect a recession. More persistent inflation and even higher rates make a recession more likely and a soft landing uncertain. In our view, recent events confirm our forecast of a mild recession in the first half of 2023.
