In 2022, the US Fed accelerated rate hikes. This year, we have seen unprecedented rate hikes since 1950 of a total of 425 basis points in 2022 alone. Previous highest hike was in 1978 where the Fed hiked interest rates by 350 bps.
Everyone is wondering how many more rate hikes are on the way. Should we anticipate more rate hikes in 2023? If yes how many more? Should we even expect a rate cut in 2023? Various experts from around the world have different perspectives. Everyone has their best estimate for a terminal rate of interest.
Preparing for the Fed’s Monetary Policy in 2023
We believe the Fed will raise interest rates again in its first policy meeting in February, possibly by 25 basis points. Why do we think so? We believe this for a couple of reasons.
US inflation peaked in June 2022, and the rate of inflation began to fall in November; it has fallen to 7.1% from 9.1% of June 2022.
There are clear indications that the Fed’s rate hike has begun to influence the economy. Even the Fed acknowledges that its rate hike will have a lag effect in terms of impact, and that this will begin to play out. To add to it, a high base effect will come into force.
Jerome Powell has stated unequivocally that inflation of 2% is non-negotiable and as a result, he will take whatever steps are necessary to bring inflation under control. Even if it means that his policies cause pain to the economy and citizens.
At the same time, Jerome Powell stated that he will not wait until inflation reaches 2% before changing his policy stance. He will reverse his policy action as soon as he is confident that inflation will reach 2%.
There is currently only one major impediment to the Fed beginning to cut interest rates: an imbalance in labor market demand and supply. Employees are in short supply in the US economy. Some businesses are not letting go of employees who are underutilized because they are unsure whether they will be able to attract the right talent when the economy improves.
We do not expect the labor demand-supply scenario to improve until the first quarter of 2023. However, we anticipate that the situation will stabilize by the second half of 2023. While we believe the Fed will begin raising interest rates by 25 basis points on February 1st, 2023, we believe the Fed will pause the next rate hike, with a 70% probability. This is due to the Fed’s desire to observe how its monetary policy affects the economy. And, if labor market demand and supply begin to balance for some reason, we expect the Fed to begin lowering interest rates in the second half of 2023.
The Road Ahead
We believe that inflation has begun to fall as global supply-side pressures ease. Falling crude oil prices, as well as freight and container costs, are positive indicators. China is still struggling due to covid, which will reduce demand and help to ease US inflation. Then there’s the lag factor. As a result, while we believe the Fed will raise interest rates in February 2023, there will be a pause followed by a rate cut in the second half of 2023.
Unlike in 2022, when the Fed may have put fear into the hearts of stock market investors, the Fed will most likely cheer them on in 2023.
(The author, Sunil Damania, is Chief Investment officer, MarketsMojo)
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