US Fed all set for 4.5% rate target by end of 2022

There are fears of recession and there are fears of a slowdown in demand, but the US Federal Reserve appears to be unperturbed. In its latest indications, the Fed officials have almost underlined that the Fed would target 4.5%  interest rate target by the end of 2022 and possibly 5% by 2023. That means the Fed would most likely spike the rates by another 75 basis points (the fourth successive 75 bps hike) in November and follow it up with another 50 bps in December. That would take the Fed rates from the range of 3.00% to 3.25% today to a level of 4.25% to 4.50% by the end of the current calendar year.

The one thing that is absolutely clear at this point is that it would take a lot to push the Federal Reserve off the path of 4.5%. This is despite the frequent warnings from investors and corporates that recession risks and financial market volatility could be the logical outcomes of such a move. In fact, the Fed is thinking of taking a quicker step to hiking the rates to 4.5% in 2022 itself so that it has the time and the leeway to take any corrective action in 2023 if required. The Fed appears to be quite convinced that it would not give up its aggressive hawkish stance unless inflation showed signs of seriously coming towards 2%.

The Federal Reserve has gone to the extent of saying that it would also be prepared to go higher if elevated inflation fails to show signs of easing. A lot would depend on the language of the US Fed minutes and the consumer inflation this week. However, the Fed is already betting on other data points. For instance, it expects that the recent 2 million bpd cut in oil supplies by the OPEC Plus is likely to keep energy prices high. At the same time, the unemployment rate in the US has come down by 20 bps which shows there is still a lot of purchasing power slack, despite higher inflation. That is a reason to keep a hawkish stance.

In the last few months, the Fed has been fighting inflation expectations more than inflation per se. For instance, in the words of the Fed, “If they did not get inflation down, people start building these inflation numbers into their daily lives”. Once the expectations of higher inflation are built in, then that ends up being the outcome. The big question is whether the Fed can achieve all this without a hard landing? There are some positive signals. For example, non-energy commodity prices are coming down, while the job vacancies and the pace of production in the factories is also slowing. These are signals it should be smooth.