MC Explains | Does the market expect the Fed to deliver another hefty rate hike?

The FOMC is the Fed’s rate-setting committee, comprising 12 members. It schedules eight meetings per year, one about every six weeks or so. The committee may also hold unscheduled meetings, as necessary, to review economic and financial developments.

At these meetings, the committee reviews economic and financial conditions, determines the appropriate monetary policy stance, and assesses the risks to its long-term goals of price stability and sustainable economic growth.

Why is the FOMC meet important?

The Fed Chairman holds a press briefing after each FOMC meeting to discuss the committee’s policy decisions and the rationale for the same.

Remarks by the Chair are closely watched in order to gauge the future course of policy actions of the US central bank. The US Fed is usually a trendsetter, in the sense that it sets the tone of the broader economic course of action that could be adopted by other central banks.

What did Fed Chairman Jerome Powell say in his last speech? What did it imply?

The last policy meeting took place on July 26 and 27, 2022, where the Fed raised the federal funds target rate by 75 basis points (bps), taking the total increase in rates to 225 bps in 2022.

That was the second Fed meeting in a row that ended in a 75 bps rate hike. Earlier, the 75 bps hike in June 2022 was the largest since November 1994.

In June, FOMC projected rates to rise to 3.4 percent by December 2022 and 3.8 percent by December 2023. Powell had earlier suggested that the Fed might taper its rate hikes after having imposed two 75 bps increases — historically large moves — in June and July.

Hence, the markets had a more dovish read-through of Powell’s speech in June and July, but his remarks at the Jackson Hole Symposium in Wyoming subsequently clarified that the Fed did not have any plans to halt its rate hike cycle.

After July’s rate-setting meeting, Powell had said at Jackson Hole that this was “no place to stop or pause” even if benchmark rates were close to being growth-neutral. The Chair explained that higher interest rates will bring down inflation, but they will also cause some pain to households and businesses.

Powell’s unexpectedly aggressive tone had made market participants jittery about the Fed announcing another big rate hike.

Has any economic data been released since the last FOMC meeting? And what is the market’s reading?

Since the July policy meeting, the labour market data has shown strength, initial jobless claims have fallen to a four-month low, and inflation has been hotter than expected, which makes a compelling case for the Fed to go for a big rate hike.

Addressing the elephant in the room, US inflation eased to 8.3 percent in August against 8.5 percent in July 2022. The print was lower than the peak of 9.1 percent in June this year, which marked the highest inflation since 1981. However, the annual pace of price rise was more than the estimated 8.1 percent. Investors believe a higher-than-expected inflation print might drive the Fed to hike interest rates even more aggressively.

First-time unemployment claims fell to 213,000 in the week ended September 10, down from the previous week's 218,000, and well below market expectations of 226,000. This was the lowest weekly jobless claims since the last week of May.

This continuing trend of falling unemployment is a positive and underlines the strength of the labour market, which provides confidence that the Fed could announce a big rate hike.

Nomura said that “Weakening retail sales and slowing manufacturing indices continue the recent trend of softening activity data, offering further evidence that the US economy is headed towards a recession.”

It added, “At the same time, the scorching August CPI print and all-time low initial jobless claims reinforce the need for rapid rate hikes to cool an overheated labor market that could start to see entrenched, high inflation.”

The brokerage firm expects a recession to start in Q4 2022, but believes increasingly entrenched inflation will likely result in continued Fed tightening through February, before cuts in Q3 2023.

What is the expectation from the upcoming Fed policy meet?

The market will closely watch the Fed’s policy action to tackle rising inflation, and look for cues about where the economy is headed. Market participants will also make note of the Fed's outlook on the inflation trajectory, which may indicate the pace of interest rate hikes in the future.

For the September meeting, the market is baking in a 75-100 bps hike in interest rates.

Nomura expects a 100 bps rate hike, as it believes that policymakers need to urgently and aggressively combat entrenched inflation.

“As a result, we revised our Fed policy rate forecast higher, including an anticipated 100 bps hike in September and a 4.50-4.75 percent terminal rate in February 2023,” the brokerage firm said.

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