Fed Chair Jay Powell and the full FOMC raised interest rates by 0.25%. That’s exactly what Jay Powell signalled and we were expecting.
The Fed is in search of what they call the terminal rate, the rate anticipated by the Fed as capable of producing steady declines in inflation without further rate hikes. Both the official statement and Jay Powell’s answer to reporters’ questions offered exceptional clarity into the Fed’s next moves. In particular, he stated that the Committee anticipates that ongoing increases in the target range will be appropriate. The word “increases” clearly anticipates more than one increase. It is also most likely that future increases will be 0.25% each.
Finally, the Fed has dropped numerous hints that the terminal rate they believe is necessary to bring down inflation on its own is 5.25% and it seems this is the path they follow. So, according to the comments made, the Fed will raise more than once more and the raises will be in 0.25% increments, and the terminal rate is 5.25%.
That schedule would look like this:
Meeting Date Rate Hike Fed Funds Target
March 22, 2023 0.25% 5.00%
May 3, 2023 0.25% 5.25%
June 14, 2023 0.00% 5.25%
But astonishingly, the markets think different and believe that the Fed will pull the plug on rate increases as early as March, stopping at a level of 5.0%. Markets anticipate that the economy will slide into recession by March. That’s the reason, why the Fed will pivot to rate cuts as early as next May. This is the soft landing scenario Wall Street is hoping for.
But what is when the market has the pivot scenario wrong?
Powell knows that a recession is a possible outcome and that unemployment will rise significantly as a result of his interest rate policy but he considers these outcomes less damaging than the return of high inflation. Of course, this does not mean that Mr. Powell is right either. The Fed probably reached the terminal rate already and simply does not know or see it yet. But then we might not see a mild recession and probably something much worse.
The combination of Wall Street pumping stocks up higher and higher and the Fed going too far could result in a steep stock market crash.
Sven Franssen