Fed seen aggressively hiking to 5%, triggering global recession

Economists see the Fed as determined not to pivot too soon as it fights against an inflation rate at a 40-year high. The shift to a higher peak rate would reflect consumer-price growth, excluding food and energy, that came in hotter than expected for the past two months. The survey of 40 economists was conducted Oct. 21-26.

“Inflation pressures remain intense and the Fed is set to hike by 75 basis points in November,” James Knightley, chief international economist at ING Groep NV, said in a survey response “We are currently forecasting a more muted 50 basis-point hike in December given a weakening economic and market backdrop,” but the risks are skewed toward a fifth 75 basis-point hike, he said.

Fed Chair Jerome Powell has said the central bank is strongly committed to restoring price stability and he’s repeatedly invoked his predecessor, Paul Volcker, who boosted rates to unprecedented levels to counter inflation in the early 1980s. Powell has warned the process will be painful, because the goal is to engineer below-trend growth to reduce price pressures and unemployment will rise as a result.

Powell and his colleagues have not given up hope that they can pull off a soft landing for the economy. But for the first time in the pre-FOMC meeting surveys, a majority of the economists -- three-quarters -- see a recession as likely over the next two years, and most of the rest see a hard landing with a period of zero or negative growth ahead.

What Bloomberg Economics Says...

“I think the most important thing to watch for is how Powell communicates the potential downshift in the pace of rate hikes. He will want to avoid giving the impression that a pivot is imminent, especially not when core inflation is clearly still going strong. He would be preparing for the markets for a 50 basis-point hike in December but which will also be accompanied with a dot plot, which shows 5% terminal rate,” said Anna Wong, chief US economist.

The economists see the Fed as potentially overtightening: The median economist would set a peak target rate at 4.75%, and 75% of the economists said there’s a greater risk that the central bank will raise rates too much and cause unnecessary pain as opposed to not raising enough and failing to contain inflation.

“Monetary-policy lags are still underestimated,” said Thomas Costerg, senior US economist at Pictet Wealth Management.  “The full effect of current tightening may not be felt until mid-2023. By then, it could be too late. The risk of a policy mistake is high.”

There could be economic spillover too to global markets, as two-thirds expect a global recession in the next two years.

While the median of economists is looking for a 50 basis-point increase in December, it’s a close call, with almost a third penciling in a 75 basis-point hike.

The rate path that economists expect is similar to the one foreseen by markets. Investors fully expect a 75 basis-point increase on Wednesday, are leaning toward a 50 basis-point hike in December and look for rates peaking around 4.8%.

If the Fed does deliver another 75 basis-point move next week, the combined increase of 375 basis points since March would represent the steepest rise in Fed rates since the 1980s when Volcker was chairman and battling sky-high inflation.

“With the Fed facing the choice of either doing too much or too little, the members will likely opt to do too much,” said Joel Naroff, president of Naroff Economics LLC, with the goal being to avoid the persistence of inflation Volcker confronted from the 1970s.

The economists expect the Fed to continue its announced reductions in its balance sheet, which started this June with the runoff of maturing securities. The Fed is reducing assets by up to $1.1 trillion a year. Economists project that will bring the balance sheet to $8.5 trillion by year-end, dropping to $6.7 trillion in December 2024.

There’s a close split on whether the Fed will move to selling mortgage-backed securities as part of the reductions, with 57% expecting the move and no consensus on the timing.

The FOMC statement is expected to retain its language giving guidance on interest rates that pledges ongoing increases, without specificity on the size of the adjustments, though a quarter are looking for softer language signaling smaller hikes.

Nearly a third of economists expect a dissent at the meeting, which would be the third of 2022. Kansas City Fed President Esther George dissented in June in favor of a smaller hike, warning that too-abrupt changes in interest rates could undermine the ability of the Fed to achieve its planned rate path. St. Louis Fed President James Bullard dissented in March as a hawk.

Beyond slowing rate hikes, the economists see the Fed eventually reversing course in response to lower growth and inflation. Most see a small first-rate reduction in 2023’s second half, with bigger cuts in 2024.