Fed update: We expect a total of 200bp rate hikes this year starting with 50bp in March

Key takeaways

• Economists, including ourselves and the Federal Reserve, continue to underestimate the underlying inflation pressure.

• The Fed is behind the curve when looking at the current economic situation (actual data), different specifications of the Taylor-rule and financial conditions.

• We change our Fed call and now expect the Fed to deliver 200bp rate hikes this year (versus 125bp previously). We expect the Fed to hike by 50bp in March and 25bp on each of the following six meetings. If so, the Fed funds target range should be 2.00- 2.25% by the end of the year.

• The door is open for an emergency rate hike near-term (like on 18 April 1994), but it is not our base case, as it is very rare. It also seems like investors misinterpreted comments from St Louis Fed President James Bullard

• We expect the Fed to hike three times in 2023 and go on hold when the Fed funds target range reaches 2.75-3.00%.

• We will not be surprised if the Fed announces it ends QE immediately although it did not happen over the weekend. We now expect the Fed to start QT in May with a cap between USD100-125bn (from June and USD75-100bn previously).

• We still see risks skewed towards the Fed pulling the emergency brake by hiking sooner and more forcefully. This also means a higher risk of a recession down the road and we will not be surprised if the yield curve inverts reflecting higher recession fears.

• The Fed needs to slow demand and reduce inflation fears by tightening monetary and financial conditions and that also increases the risk of a hard landing instead of a soft one.

Fed will hike by 50bp in March

Based on last week’s higher-than-anticipated CPI inflation print and Fed’s James Bullard’s hawkish comments, we are once again changing our Fed forecasts. We now expect the Fed to deliver a total of 200bp rate hikes this year with a 50bp rate hike in March and 25bp on all following six meetings. 50bp is a large hike but would reflect that the Fed recognises it is behind the curve. The last time the Fed hiked by 50bp was in May 2000. If we are right, the Fed funds target range should be 2.00-2.25% by the end of the year. The timing is difficult and we see risks as skewed towards the Fed front-loading some of the rate hikes by making more 50bp rate hikes.

We expect the Fed to hike three times in early 2023 and go on hold when the Fed funds target range reaches 2.75-3.00%.

We still see risks skewed towards the Fed pulling the emergency brakes by hiking sooner and more forcefully.

Download The Full Fed Update