Fed will again turn the interest rate screw vigorously

The risk is growing that the U.S. Federal Reserve is overdoing it with its tight interest rate policy, Pictet says. (Image: Shuttertock.com/Andriy Blokin)

The Federal Reserve is expected to issue another "jumbo" this Wednesday-Make interest rate hike of 75 basis points. The interest rate ceiling is thus likely to rise to 4.0 percent. The Fed's be-all and end-all remains core inflation, which remained high at 6.6% – against headline inflation of 8.2% – according to the latest figures from September, and has yet to tilt lower for some time, finds Bank Pictet.

Despite growing political pressure – some Democratic senators have written open letters to Fed Chairman Jerome Powell – and the deterioration of some leading growth indicators, the Fed will stick to its "stick to its guns" strategy And continue to give priority to fighting inflation.

Quantitative tightening is expected to continue unchanged in the background, adding about 1 trillion dollars to the Fed's balance sheet over the next 12 months. U.S. dollar to shrink, writes Thomas Costerg, senior U.S. economist at Pictet Wealth Management, on the Fed meeting this Wednesday.

Inflation begins to settle in

More worrisome for the Fed is the persistence of consumer inflation expectations. The Michigan Institute's one-year inflation expectation was still a high 5.0% in October. "This, in turn, fuels the Fed's fears that inflation could become entrenched as it was in the 1970s and, in our view, could explain why Jerome Powell will not commit to an end to monetary tightening now", Economist Costerg says.

Consumer inflation expectations remain high

The U.S. Federal Reserve is also looking hard at the labor market. Employment continues to rise and remains robust. The unemployment rate is hovering at a low of 3.5 percent.

By contrast, the problems in the housing market, reflected in a 30% drop in sales commitments in September, are being ignored, Costerg notes. Some Fed members believe this is a necessary evil to combat overheating during the Corona crisis, he said. Others may welcome the fact that it could lead to a slowdown in rent growth, which has been a major driver of U.S. inflation recently.

Interest rate hikes not yet over

Although Jerome Powell may allude to a slower pace of rate hikes and possibly the next meeting in December, "we think it is unlikely that he will announce an end to the rate hike cycle as Neighbor Bank of Canada recently did.", Pictet holds.

Money markets currently expected the Fed rate to peak near 5% by May 2023. This is well above the 4.6% final rate quoted by the Federal Reserve in September.

It's hard to imagine Powell signaling an end to tightening any time soon, he says. Fed's priority is fighting inflation "and recent data just aren't good enough", Costerg explains. The Fed is willing to take the risk of an economic recession and is far from recovering faith in Keynesian-style economic models of the future "showing a rise in the output gap that is disinflationary by 2023, or even monetarist models showing a sudden contraction in liquidity." The Fed is acting "day by day".

Risk of exaggeration grows

For Pictet, the Fed's stringent fight against inflation is not without danger. Economist Costerg points to risk of excessive tightening. This is increasing, especially in an environment of high debt and shrinking market liquidity, and the Fed is being mimicked by the other major central banks in its pronounced stance.

"It could be that the Fed may be paying too little attention to the large amounts of debt in the international financial system." Thomas Costerg speaks of a "very delicate moment for monetary policy in the U.S. and elsewhere," given the resilience of inflation. We believe that the window of opportunity for the rosy scenario of a soft landing is narrowing from Fed meeting to Fed meeting."

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