• A higher interest rate for longer looks to be the way forward for Federal Reserve. We expect it to hike Fed Funds rate at least another 125bp and keep it here.

  • The market agrees and discounts another 121bp hikes this year and now only discounts 14bp of interest cuts next year from 50bp in July.

  • In our view, the US output gap turned positive and the economy needs a period of restrictive monetary policy to return to equilibrium.

If the US economy is on the brink of recession, the front end of the US money market curve is not paying attention. The money market discounted 50bp interest cuts from Federal Reserve next year in July. It only discounts 14bp now. We find it reasonable for the market to pull back on expectations for interest rate cuts next year. Further, a couple of excerpts from the latest FOMC Minutes published on Wednesday backs our view.

“Even so, with inflation elevated and expected to remain so over the near term, some participants emphasized that the real federal funds rate would likely still be below shorterrun neutral levels after this meeting's policy rate hike.”

The 1Y real interest rate based on consumer’s inflation expectations (we use an average of surveys from University of Michigan, New York Federal Reserve and Conference Board) is about 1.5pp below the peak in 2018. In our view, Federal Reserve needs to increase the real interest rate to at least this level to combat inflation and possible even more. At least another 125bp of hikes over the coming months, as we expect, in combination with a moderation of inflation expectations would likely do the trick.

Financial conditions eased over the summer and some commodity prices started to recover – another signal that monetary policy is not restrictive enough yet. Thus, in order to avoid a resurgence in inflation, Federal Reserve needs to appreciate the USD, increase yields, weaken equities and/or widen credit spreads through tighter monetary policy.

“Some participants indicated that, once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2 percent.”

Real GDP recovered near the pre-pandemic trend, but labour force participation remains lower. We do not think the economy has reached a new equilibrium, but rather that the output gap turned positive. The imbalance is the most evident in labour markets, where despite the recent easing in labour demand, job openings per unemployed remain near record-levels.

Unless demand is brought back to equilibrium, US economy could face an extended period of inflation exceeding the 2% target. Keeping interest rates at a mildly restrictive level for a period of time is one way to get rid of excess demand. Another would be to raise interest rates to a very restrictive level, e.g. by another 2-300bp. That would lead to a faster normalisation and open up for interest cuts next year. The money market, Federal Reserve and we lean towards the former scenario.

Download The Full Research US

This publication has been prepared by Danske Bank for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Bank's research analysts are not permitted to invest in securities under coverage in their research sector.
This publication is not intended for private customers in the UK or any person in the US. Danske Bank A/S is regulated by the FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange.
Copyright () Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.

Feed news Join Telegram

Recommended Content


Recommended Content

Editors’ Picks

EUR/USD stays below 0.9800 after US inflation data

EUR/USD stays below 0.9800 after US inflation data

EUR/USD continues to trade in negative territory below 0.9800 in the American session on Friday. The data from the US showed that the annual PCE inflation declined to 6.2% in August but the stronger-than-expected core reading didn't allow the pair to gain traction.

EUR/USD News

GBP/USD rebounds from daily lows, reclaims 1.1100

GBP/USD rebounds from daily lows, reclaims 1.1100

GBP/USD fell to a fresh daily low below 1.1030 but managed to reverse its direction and climbed above 1.1100 during the American trading hours on Friday. The pair remains on track to snap a two-week losing streak despite having suffered heavy losses earlier in the week.

GBP/USD News

Gold extends daily rally beyond $1,670

Gold extends daily rally beyond $1,670

Gold preserved its bullish momentum and rose above $1,670 after the mixed inflation data from the US on Friday. The benchmark 10-year yield is down more than 2% as markets look to wrap up the third quarter, fueling XAU/USD's daily rally. 

Gold News

Shiba Eternity download day the biggest bullish catalyst in SHIB history?

Shiba Eternity download day the biggest bullish catalyst in SHIB history?

Shytoshi Kusama, the project lead for Shiba Inu, has dropped a teaser about Shiba Eternity games for the SHIB community. Proponents expect the launch of the collectible card game to be a bullish catalyst for Shiba Inu price. 

Read more

SPDR S&P 500 ETF Trust (SPY) Forecast: We are teetering on the brink

SPDR S&P 500 ETF Trust (SPY) Forecast: We are teetering on the brink

Equity markets remain at the precipice of a technical collapse, which we examine in the weekly long-term chart below. The overall picture remains one of nervousness ahead of the upcoming Q3 earnings season.

Read more

Majors

Cryptocurrencies

Signatures