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Traders bet on a rise of only half a point. Fed Funds Futures on the Chicago Mercantile Exchange show an 80% chance of a half-point upside.
The Fed rate increase of three-quarters of a percentage point at the last four meetings (June, July, September and November). This followed two small rate hikes earlier this year. The central bank’s main short-term interest rate, which was at zero at the start of the year, is now in a range of 3.75% to 4%.
The hope is that inflation pressures are finally beginning to decline enough for the Fed to pivot – The Fed is talking about a series of small rate hikes – to avoid plunging the economy into a recession.
But it may not be that simple. The government announced on Friday that a key measure of wholesale prices, the producer price index, rose 7.4% in the 12 months to November. That was a little higher than the expected rate of 7.2%, but a marked slowdown from the 8% increase through October.
The most-watched consumer price index data for November comes out on Tuesday, just a day before the Fed’s announcement. The CPI rose 7.7% year-on-year through October.
As long as inflation remains a problem, the Fed will have to tread carefully.
“Inflation has probably peaked, but it may not come down as quickly as people want it to,” said Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research.
Jones still thinks the Fed will only raise rates by half a point this week and may be looking to raise rates by just a quarter point in early 2023. But she admitted the Fed is now in the process of “catch up as you go”.
The other problem: The Fed’s rate hikes this year have so far had a limited impact on the economy. Yes, mortgage rates have skyrocketed and this has severely hurt housing demand, but the labor market remains strong. Wages are rising and consumers continue to spend. This cannot last indefinitely.
“The cumulative impact of higher rates is just beginning. Therefore, the Fed needs to slow down a bit,” Jones said.
Investors will therefore have to pay attention not only to what the Fed says in its rate policy statement and what Powell talks about in his press conference. The Fed will also release its latest projections for gross domestic product growth, the labor market and consumer prices on Wednesday.
In September, the Fed’s consensus forecast called for GDP growth of 1.2% in 2023, an unemployment rate of 4.4% and an increase in personal consumption spending, the preferred measure of the Fed or the inflation, 2.8%. It seems likely that the Fed will lower its GDP target and raise its expectations for the unemployment rate and consumer prices.
The probability of an economic slowdown is increasing, and the Fed’s projections could take this into account. But the Fed isn’t expected to start cutting interest rates until 2024 at the earliest, so it may be too late for the central bank to prevent a recession.
“A pivot or pause is not a panacea for this market,” said Keith Lerner, co-chief investment officer at Truist Advisory Services. “Rate cuts may be too late. Recession risks are still relatively high.
The US economy is not yet in recession. But are American buyers exploited? We’ll have a better idea this Thursday after the government releases retail sales figures for November.
Economists are actually forecasting a slight 0.1% drop in retail sales from October. But it is important to put this number in context. Retail sales jumped 1.3% from September and 8.3% over the last 12 months.
So it’s possible that consumers were simply getting a head start on holiday shopping. Inflation is also having an effect on the numbers, as retail sales have been impacted (positively) by people having to spend more money on things.
A market strategist also pointed out that as long as price increases continue to slow, consumers will also feel more confident.
“Everyone has been talking about inflation this year. Going forward, it will be more about disinflation in 2023 or 2024,” said Arnaud Cosserat, CEO of Comgest Global Investors.
What does this mean for investors? Cosserat said people should look for quality consumer companies that still have pricing power and can maintain profit margins. Two stocks his company owns that he says fit this bill: luxury goods maker Hermes
(Account) and cosmetics giant L’Oréal
Monday: UK Monthly GDP; Oracle revenue
Tuesday: consumer price index in the United States; Germany Economic Sentiment
Thursday: US retail sales; weekly jobless claims in the United States; ECB and Bank of England rate decisions; Jabil’s income