US Fed minutes suggest rate hikes may continue into 2023

The Fed rate hikes are continuing for now and the Fed would be relentless in its anti-inflation stance. However, the members of the Fed are totally confused with one thing. The idea of aggressive rate hikes was that it would impact growth to some extent but also bring down inflation. However, the outcome is that the growth has come down, and even dipped into negative. However, inflation is showing no signs of relenting. Rates have been headed higher for some time now but there is just no respite on the inflation front. That is the big problem that the members of the Fed are facing.

Look at the progress on rate hikes till now. Since March 2022, Fed rates have been increased by a full 300 bps from the range of 0.00%-0.25% to the current rate of 3.00%-3.25%. Despite that inflation continues to be higher and growth is in negative territory. The problem is so acute that the Fed is still talking about another 75 bps rate hike in November and another 50 bps rate hike in December 2022. Approximately, that would push rates to the range of 4.25%-4.50% by the of 2022. The terminal rate target of 4.6% and an aggressive terminal rate target of 5% looks to be the new reality for Fed rates in the US now.

What the CME Fedwatch says about likely rates in coming months?

The CME Fedwatch assigns implied probabilities of rate hikes. These are based on the trading in Fed rate futures. Here is how rates could rise in the next 5 Fed meetings.

The moral of the story is that rates could get to 4.5% positively by the end of 2022 and to 5% by the end of June 2023.

Key inferences from the minutes of the Fed meet

Here are some key inferences we can draw on the inflation and the rates front.

    a) Long term inflation will be driven by supply chain challenges and labour shortages are resulting in higher manpower costs. That is also pushing up inflation in a big way; also called the labour slack of too much labour shortage.

    b) Fed officials believe that rates may not rise until inflation comes all the way down to 2%. They will wait for a confirmatory trend from the rates. Once the inflation starts downward journey, the Fed is likely to apply the brakes on rate hikes.

    c) Rate hikes will be 95% frontloaded in the year 2022 itself and perhaps some minor tweaks in the 2023 year. However, the indication is that if growth becomes a priority, Fed may even be open to rate cuts. 

    d) Terminal rate projections have clearly moved higher from 4.6% in a most likely scenario by early 2023 to a possible scenario where the range of 5.00-5.25% is also tested.

Finally, the big question is what these minutes mean for India? It is a sort of a choice between the devil and the deep sea for the RBI. On the one hand, inflation is higher at 7.41% and IIP has contracted by -0.83% and all this is after 190 bps of rate hikes. RBI now needs to quickly decide whether to chase inflation or chase growth. One thing is clear that high inflation and low growth are forming a nasty amalgam of macro factors for the RBI. It is not clear if the answer is to go the US way or go the China way. Perhaps, the latter may suit the India interests better. We have to wait and watch.