By Wei Hongxu*
On November 2, the Federal Reserve announced raising interest rates by 75 basis points, which means that the target range of the federal funds rate was raised by 75 basis points from 3.00%-3.25% to 3.75%-4.00%. This is the fourth consecutive rate hike by the Fed this year by 75 basis points. The Fed said it expected to appropriately continue raising the target range. Prior to this, some analysts called for the Fed to slow down the pace of interest rate hikes to avoid undue impact on the economy. However, with U.S. inflation remaining high, most market participants still expect the Fed to maintain a 75-basis-point rate hike. Therefore, the decision this time is not out of the market’s expectations.
When it comes to the future Fed policy trends, judging from the information revealed at the latest meeting, it appears to be a mixed bag of good and bad news. The Fed said in the press release after the meeting that the current target range for continuing to raise the benchmark lending rate would be appropriate, but it would also “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”. This is interpreted by the market as the rhythm of subsequent interest rate hikes, which will be moderate as the impact on the economy becomes increasingly apparent. Fed Chair Jerome Powell said at a press conference after the regular monetary policy meeting that the speed of rate increases could slow in the future. “At some point, it will become appropriate to slow the pace of increases,” he said. “That time is coming, and it may come as soon as the next meeting or the one after that”. He emphasized that there is no recession in the United States, but the possibility of a soft landing is shrinking. However, he also noted that it is too early to consider a pause in interest rate hikes, and the current round of terminal interest rates may be higher than previous estimates.
In the opinion of researchers at ANBOUND, Powell’s statement carries two implications. In terms of the pace of interest rate hikes, the Fed will start to slow down as inflation falls from a high level in the future to avoid excessive impact on the economy. On the one hand, it will wait for the full release of policy effects to improve policy efficiency. On the other hand, slowing interest rate hikes will help avoid excessive economic downturns and make soft landing more possible. This also means that a 50 basis point rate hike is likely in December, which will be reduced to 25 basis points at a time.
Powell’s speech means that the cycle of this round of interest rate hikes will be longer, and the target rate will also be higher. Considering that the final interest rate adjustment indicated by the Fed’s dot plot in September was 4.6%, Powell’s speech this time indicates that the latest rate hike is expected to be 5%. Assuming a 50 basis point rate hike happens in December, the Fed will need to raise rates at least twice in 2023, with each rate hike of 25 basis points. This was longer and by a larger margin than previously expected by the market. Because of this, Powell’s speech sparked another drop in U.S. stocks.
The changes and trends in the Fed’s monetary policy are basically in line with the policy path estimated by researchers at ANBOUND in September. The slowing down in the pace of future interest rate hikes means that after this round, the Fed’s monetary policy may enter a new stage, moving away from a more intensive one to curb inflation to a more lasting moderate one to control inflation and stabilize the economy. Judging from the current strong performance of the U.S. economy, the possibility of a soft landing in the future still exists under a more moderate policy.
If the politicization tendency of the Fed is taken into account, after the U.S. mid-term elections in November, its tightening rhythm has no motivation to meet the electoral needs of the current U.S. government, and will further adjust to the direction of economic needs. In addition, although U.S. inflation remains high, it has shown signs of peaking, which makes the Fed need to shift from the previous intense interest rate hikes to stabilize the economy.
It should be noted that, as mentioned by ANBOUND before, the final value of the 5% policy adjustment is on the verge of an extreme situation. In this case, the loan interest rate of U.S. banks will reach an unbearable level, where home loan interest rates may rise to more than 10%. Therefore, the Fed will not seek to take a one-step-fix-all solution but will leave room for more flexible adjustments based on the economic conditions reflected in various data. At the same time, under the Fed’s new average inflation target policy framework, its policy shift will still lag behind the changes in economic data, which means that the tightening cycle of its monetary policy will be longer than the market expects. This, in turn, could have a negative impact on the U.S. economy. In other words, the Fed’s monetary policy might still create blunders.
The Fed’s more moderate policy adjustment approach in the future also signifies that the policy risks faced by the market will be significantly reduced, which will bring relief to the already shaky financial market. The pressure on currencies of various countries, including the Chinese yuan, will also be eased as the pace of U.S. dollar appreciation slows down. That being said, it does not mean the pressure will disappear. The dollar will remain strong until a fundamental change in the Fed’s policy cycle, and the likelihood of stagnation or recession in countries including the U.S. will continue to increase.
Final analysis conclusion:
The Federal Reserve’s latest rate hike decision and its outlook indicate that its monetary tightening policy has shifted from an aggressive one to a more moderate one. This significantly reduces both policy effectiveness and policy risk. However, with the Fed’s longer monetary policy cycle and higher interest rate hikes, the global economy and financial markets will still face continued pressure in the future.
Wei Hongxu is a researcher for Anbound
Anbound Consulting (Anbound) is an independent Think Tank with the headquarter based in Beijing. Established in 1993, Anbound specializes in public policy research, and enjoys a professional reputation in the areas of strategic forecasting, policy solutions and risk analysis. Anbound’s research findings are widely recognized and create a deep interest within public media, academics and experts who are also providing consulting service to the State Council of China.