How long will US Fed keep raising the interest rate?

File image of Federal Reserve Chair Jerome Powell (AP photo)

The US Federal Reserve Chairman Jerome Powell on November 2 batted away any hopes investors had of the central bank pivoting towards a more dovish outlook on interest rates amid rising fears of a recession.

While the statement of the US Federal Open Market Committee (FOMC) appeared to indicate that the central bank will lower the quantum of interest rate hikes going ahead, Fed Chairman Jerome Powell indicated that interest rate now need to move much higher than where the FOMC expected it in September.

Powell told media reporters that there is historical record to caution policymakers strongly against prematurely loosening monetary policy during periods of high inflation. The Fed chief suggested that there was “ways to go” before the Fed’s job of getting inflation in the US under control.

Traders are now expecting the central bank to continue to raise interest to 5-5.25 percent by the end of March 2023 from current level of 3.75-4 percent, indicating another 125 basis points of hike, according to CME FedWatch tool.

In July, traders were piling up bets that the Fed will be forced to cut interest rate by 25 basis points in March 2023 because of a recession in the US by the end of the current year.

Economic data over the past few months have showed little sign of stress in the US economy. GDP in the September quarter rose 2.6 percent year-on-year, much higher than the Wall Street expectations.

Further, job additions and job openings continue to remain high, while more than $1 trillion of household savings in the US indicate that consumers have savings to protect themselves against higher prices.

Traders are now expecting the Fed to pause on interest rate hikes from March till October likely because of slowing economic growth as well as inflation moderating purely because of base effect.

“Higher base effect will start kicking in by the end of this year and most commodity prices are at pre-Covid levels and falling. This combination will bring Inflation down and within comfortable zone,” Carnelian Capital said in a note.

Market participants expect the first cut in interest rate by the US Federal Reserve at the November 2023 or December 2023 monetary policy meeting of the central bank.

What it means for RBI?

With the Fed likely to raise interest rates by another 125 basis points, the Reserve Bank of India may have little option but to continue raising interest rates at home.

The recent minutes of the October monetary policy meeting of the RBI had traders betting that the rate-setting panel may only raise by another 35 basis points at the December policy meeting and then pausing to see inflation moderate in the coming quarters.

Yield on the 10-year benchmark government bond on November 3 jumped 5 basis points as traders anticipating more rate increases from the central bank following the commentary of the US Fed.

The MPC will meet today to discuss the content of the letter it has to write to the Parliament explaining the reasons for failue in ensuring inflation remained within its 2-6 percent band in the previous three quarters.

RBI Governor Shaktikanta Das’ hawkish commentary on inflation at recent events suggests that the central bank may not be done with rate hikes any time soon.

“Our constant endeavor is to keep an Arjuna’s eye on inflation, which is our primary target,” Das said at an industry event on November 2. He went onto suggest that the MPC aim of ensuring price stability need not impinge upon sustained economic growth and financial stability.

“The rate hike cycle is still not over, but liquidity may stay tight,” Nomura’s Sonal Verma and Aurodeep Nandi said in a note.

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