Federal Reserve expected to slow pace of interest rate hikes to kick off 2023

The Federal Reserve will begin its first policy meeting of the year on Tuesday, with investors expecting Wednesday’s policy statement to show interest rates rising at a slower pace for the second straight meeting.

Markets are pricing in a nearly 100% chance that the Fed will raise its benchmark interest rate by 25 basis points on Wednesday, a move that would bring the key rate back to a range of 4.5% to 4.75%.

A chorus of Fed officials signaled that a quarter-point rate hike would be announced on Wednesday, which would mark a further slowdown from the half-percentage-point hike announced in December.

Prior to the December announcement, the Fed had raised rates by 0.75% at each of its previous four meetings.

The Fed will announce its latest policy decision at 2:00 p.m. ET on Wednesday, with Fed Chairman Jerome Powell scheduled to hold a press conference at 2:30 p.m. ET. The Fed will not offer an updated economic forecast on Wednesday.

“There appears to be little turbulence ahead, so I currently favor a 25 basis point hike at the next FOMC meeting at the end of this month,” the Fed Governor said. Chris Waller said earlier this month. Philadelphia Fed President Patrick Harker said: “[In] in my view, 25 basis point hikes will be appropriate going forward.”

Boston Fed President Susan Collins and Dallas Fed President Lorie Logan said earlier this month they favor raising rates at a slower pace, but did not outright identify 25 basis points as the magnitude of the necessary rate increase. Logan will be a voting member of the Federal Open Market Committee — the Fed committee that votes on monetary policy — for the first time this week.

Federal Reserve Board Chairman Jerome Powell speaks at a press conference following the announcement that the Federal Reserve has raised interest rates by half a percentage point, at the Federal Reserve building in Washington, U.S., December 14, 2022. REUTERS/Evelyn Hockstein

Federal Reserve Board Chairman Jerome Powell speaks at a press conference following the announcement that the Federal Reserve has raised interest rates by half a percentage point, at the Federal Reserve Building in Washington, U.S., December 14, 2022. REUTERS/Evelyn Hockstein

Expected rate hikes will slow as inflation has shown signs of easing, although price increases remain well above the Fed’s 2% target.

The Fed’s favorite measure of inflation, the index of personal consumption expenditure excluding food and energy, increased by 4.4% in December compared to a year agodown from 4.7% in November and marking the slowest annual growth rate since October 2021.

At the same time, the “core” consumer price index, which excludes food and energy prices, edged up 0.3% in December, after rising 0.2% in November. Year after year, Core CPI rose 5.7% in Decemberdown from the 6% pace seen in November.

“Fed Chairman Powell will have to acknowledge the encouraging inflation data,” said Wilmington Trust chief economist Luke Tilley. “This is not an isolated case. We have had three months of encouraging data.”

Tilley thinks that despite encouraging inflation data, the Fed will use hawkish language on Wednesday because officials don’t want financial conditions to loosen too much and are still watching wages. “Powell wants to stay the course and do no harm,” he said.

Rising stock prices and moderating interest rates have led to financial conditions have eased considerably since the October peak.

Wilmer Stith, bond portfolio manager for Wilmington Trust, said he doesn’t expect the Fed to raise pause rates this week given easing financial conditions. “I think the Fed will hold out until the end of the year and not reduce [rates] to secure tighter financial terms,” Stith said.

The economy also showed signs of slowing with slowdown in consumer spending in the fourth quarter as companies cut spending on equipment. In recent weeks, new data has shown a drop in manufacturing activity, lower retail salesand layoffs extending beyond the tech sector.

Investors will also be looking for clues about the further increase in the Fed’s benchmark rate. And when the Fed could suspend rate hikes altogether.

“There could be one last hawk bite in the tail,” said Paul Ashworth, chief US economist at Capital Economics. “We are waiting [Wednesday’s] statement to maintain language that “continued increases” (emphasis on plural) in rates will be required and, to counter recent easing in financial conditions, forward guidance could be added that commits to let rates at high levels for some time.

Most Fed officials estimated in December that the key rate would peak between 5% and 5.25%, implying two more quarter-point increases.

Officials said they did not want to make the mistake of not raising rates enough, which would lead to a resurgence of inflationary pressures in the economy.

“Even after we have enough evidence to suspend rate hikes, we will need to remain flexible and raise rates further if changes in the economic outlook or financial conditions warrant it,” Dallas Fed Chair Lorie said. Logan, in a recent speech.

Tilley, like other market participants, believes inflation and the economy are slowing faster than the Fed thinks and expects a rate cut in the fourth quarter.

“Even if they cut rates, they still have the brakes. They would just let up a bit,” Tilley said. “If they keep the fed funds rate at 5% and inflation comes down, then on an inflation-adjusted basis, the Fed is passively tightening at this point.”

From a risk management perspective, however, Fed officials believe the central bank needs to hedge against falling inflation, noting that in 2021 there was a decline in inflation under underlying for three consecutive months before rising.

“We don’t want to be rigged,” Waller said. “But if we’re wrong and inflation falls faster than expected, then it’s easier to cut rates.”

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