Following Wednesday’s meeting, the Fed expectedly raised rates by 0.5 p.p. to a 4.25-4.5% level, keeping the text of its final press release unchanged from November, indicating the need for further rate hikes to fight inflation. The Fed also maintained the current pace of its $95 billion a month balance sheet reduction. The rate forecast for the end of next year was raised from the September meeting by 0.5 p.p. to 5.1%. Thus, members of the Federal Open Market Committee (FOMC) expect to raise the rate by another 0.75% during 2023.
During the press conference, Fed Chairman J. Powell said that in the future there is no need to raise the rate by big steps, because the Fed has already reached the level at which there is a slowdown in economic activity and inflation. Thus, the regulator is moving to fine-tune the level of the interest rate in order to avoid raising it above the required level. We can expect that if the observed trends of slowing inflation continue by the Fed meeting on February 1, 2023, the rate will be raised by only 0.25%.
The Fed’s projected rate of 5.1% at the end of next year significantly exceeds the expectations of market participants, who anticipate that the Fed will move to lower the rate as early as the second half of next year. As a result, financial markets reacted by lowering the results of the Fed meeting, but selling in the markets was limited: the market is skeptical about the forecast of the Fed keeping the rate at such a high level for so long, as it expects that the rapid deterioration of economic conditions in the first half of next year will force the Fed to move to easing of monetary conditions in the second half of 2023.
On the other hand, market players may underestimate the Fed’s tolerance of a worsening economy for the sake of its inflation target: the GDP growth forecast for the next year was lowered from 1.2% to 0.5% y/y, while the expected unemployment rate rose by 0.2 p. p. to 4.6% from 3.7% in November. This rate of economic growth actually indicates that FOMC members are expecting a recession next year. However, as the head of the Fed has said many times before, achieving price stability is now more important to the Fed than full employment.
Will the Fed’s actions cause a global recession in 2023? I still expect so. During the previous cycle of rate hikes in 2015-2018, the Fed reached only 2. The Fed only reached a 2.5% rate at which the global economy began to slow rapidly, even though the ECB was cutting rates and implementing quantitative easing back then. Now both central banks are rapidly tightening monetary policy, and the level of the Fed rate of 4.5% is already close to the level the Fed reached before the global crisis of 2008-2009 (5.25%).
The world economy is still showing inertial growth, which, however, should come to naught as early as Q1 of next year, beyond which there is a high level of uncertainty. We are only dreaming of peace.
