Fed likely to go higher, meaning steeper rate cuts later in 2023

On Thursday, October US CPI data will be released and should have an impact on the market and also on expectations about the Federal Reserve’s monetary policy. Bill Diviney, Sr. Economist at ABN AMRO, points out they now expect the FOMC to aim for a higher peak in interest rates, but this is likely to mean even steeper rate cuts later in 2023, once conditions allow.

Key Quotes:

“Following the 50bp hike we already expected in December, we now expect two further 25bp hikes at the February and March meetings. This will take the upper bound of the fed funds rate to 5%. However, we still expect significant rate cuts in H2 23, and if anything, the higher peak in rates implies a steeper drop-off, once macro conditions in the US allow for this.”

“We expect cuts to start somewhat later, in September rather than our prior expectation of July, but we also expect 125bp total rate cuts, up from 100bp previously. This will take the form of one 25bp cut in September, followed by two 50bp cuts in November and December. Thereafter, we expect the Fed to downshift to 25bp cuts until rates fall back to the Fed’s neutral estimate of 2.5% by mid-2024. From there we expect the Fed to pause.”

“With the Fed now more likely to overshoot in its rate hikes, we think that falling inflation next year combined with a deteriorating labour market will convince the Committee that rates are too restrictive, and that it will want to recalibrate policy before high rates do more damage to the economy than is necessary to bring inflation back to target.”

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