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Fed hikes rates by 75 bps in November, for fourth time in succession

Even a few weeks ahead of the November Fed statement on 02nd November 2022, there was hardly any doubt about a 75 bps rate hike. That is exactly what the Fed delivered in its policy statement on Wednesday.

November 03, 2022 9:28 IST | India Infoline News Service
While the Fed maintained its stance of staying hawkish till inflation came under control, economists interpret it as a signal that the rate hike may be just 50 bps in December and perhaps a few minor rate hikes after that.

With the latest 75 bps rate hikes, the interest rates have scaled up to the range of 3.75% to 4.00%. Since March, the Fed has hiked rates by 375 basis points, with the last 4 Fed meets hiking rates by 75 bps in a row. The Fed, in its statement, also hinted that the terminal rates would be much higher than originally anticipated and it is now being pegged at closer to 5%.

The Fed has, perhaps, taken solace from the fact that GDP growth estimates indicated a turnaround to positive growth in Q3 after two quarters of negative GDP growth. However, this turnaround was led by a reduction in trade deficit even as consumption continued to lag. However, we have to await the minutes of the Fed meeting for greater clarity.

Sorry, peak rates are now converging beyond 5%

Here is a quick look at the CME Fedwatch implied probabilities. Rates have already risen from the range of 0.00%-0.25% to the range of 3.75%-4.00% between March 2022 and November 2022. Here are the implied Fed rate scenarios over next 9 meetings.

Fed Meet 400-425 425-450 450-475 475-500 500-525 525-550 550-575 575-600 600-625
Dec-22 Nil 61.5% 38.5% Nil Nil Nil Nil Nil Nil
Feb-23 Nil Nil 23.9% 52.6% 23.6% Nil Nil Nil Nil
Mar-23 Nil Nil 5.8% 30.8% 45.5% 17.9% Nil Nil Nil
May-23 Nil Nil 3.8% 22.7% 41.1% 26.8% 5.6% Nil Nil
Jun-23 Nil Nil 3.6% 21.5% 39.8% 27.7% 7.0% 0.4% Nil
Jul-23 Nil 0.5% 6.2% 24.2% 38.0% 24.6% 6.1% 0.3% Nil
Sep-23 0.1% 1.7% 10.0% 27.1% 35.2% 20.7% 4.9% 0.3% Nil
Nov-23 0.7% 5.0% 16.7% 30.3% 29.6% 14.5% 3.1% 0.2% Nil
Dec-23 3.0% 10.1% 22.6% 29.9% 23.0% 9.5% 1.8% 0.1% Nil
Data source: CME Fedwatch

Powell has himself admitted that the final destination was uncertain, but the CME Fedwatch indicates that this terminal rate could be somewhere between 5% and 5.50% depending on how the US economy reacts to the series of rate hikes. For now, the Fed is in no mood to relent on rates hikes, at least till the time inflation shows signs of moving appreciably lower.

·         With 300 bps rate hike done in the last 4 meetings, the Fedwatch is hinting at another 50 bps rate hike in December and a few more smaller rate hikes in 2023.


·         The probabilities indicate the Fed rates would almost certainly be above the 5% mark by March 2022 and that would be the point that the Fed will have to make some serious calls as the rate would reflect a 250 bps premium to the neutral rate.


·         Between now and December, a lot will depend on how inflation pans out and if the consumer inflation (especially food and core inflation) stay at elevated levels, then the Fed may be inclined to gravitate to another 75 bps rate hike in December this year.


·         While the front loading of rates is a reality in 2022, there are two possibilities in 2023 as indicated in the CME Fedwatch. Firstly, there is a strong possibility of another 50-75 bps piecemeal rate hike in 2023. However, there is also a window open, wherein the Fed may cut rates if the growth impact is too stark. However, that seems remote as of now.

The moral of the story is that the Fed is not done with its hawkish stance and it will relentlessly pursue rate hikes till inflation came to 2%. That is assuming that the growth levers do not get inordinately damaged in the process.

Key takeaways from the November 2022 FOMC statement

Here is what we read between the lines of the Fed statement issued late on 02nd November 2022. The message is that the most aggressive tightening in the last 40 years, is far from over and the Fed is taking inflation head-on. Now for the key takeaways.

a)      One can interpret it as a double-edged message from the Fed. It has hinted at more rate hikes of a smaller magnitude in the future, but the intent of the Fed is unlikely to slacken till inflation starts its decisive journey towards 2%.


b)      Powell has hinted at the fact that he was willing to take the rates to a sufficiently restrictive level. Currently, the rates are already 150 bps above the neutral rate and 250-300 bps above  neutral should put substantial pressure on growth levers.


c)      For the first time, Powell has indicated that the terminal rate of interest could gravitate closer to the range of 5.0%-5.5% range, although he has just indicated that the terminal rates would be substantially higher than previously envisaged.


d)      Looking at the reaction of the Dow, S&P 500 and the NASDAQ post the Fed statement announcement, it is clear that markets were far from impressed. The aggressive dot plot chart does keep the markets on tenterhooks with negative implications.


e)      In a cryptic statement, Powell has mentioned that "In determining the pace of future increases, the Committee would take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments." That may be broad and vague, but is encouraging that the Fed is willing to take a more holistic picture of rate hikes.


f)       The September Fed meeting had indicated at rates peaking at 4.50%-4.75% in 2023, but now the Fed has indicated that it could more likely be in the range of 5.25%-5.50% with a very low probability of going beyond that. That means, the Fed would not be done with its rate hikes in 2022, with more to come in 2023.


g)      The big question is whether this policy statement can be called a “step-down”. We have to wait till December to see if the rate hikes are toned down to 50 basis points, although that is still extremely aggressive. The answer would lie in the interim data on inflation and high frequency growth indicators between now and December 2022.


h)      One more takeaway from the Fed statement is that Powell appeared less confident about a soft landing with the higher terminal rates indicated. That means, the lower inflation will come with a violent growth impact too. However, Fed is also confident that the Fed would be able to tweak rates in a way without pushing the US into contraction.
 
What the Fed statement means for the RBI and for India?

It is hardly a coincidence that the RBI MPC is meeting exactly a day after the Fed meet. The real agenda may not be its anti-inflation policy but about reacting to the 75 bps rate hike by the Fed. At a time when emerging markets are already under pressure, another aggressive rate hike would negatively impact portfolio flows. Also, a stronger dollar would mean more imported inflation for India.

The RBI may, in all probabilities, effect a rate hike of around 40-50 bps as part of the interim MPC review. That would quell the fear that outflows could escalate and rupee could weaken further. RBI is yet to spell out its terminal repo rate target, but it has to surely be higher than the Fed target.

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