Fed hikes rates by another 75 bps; how much further?

It was almost like a fait accompli, meaning the 75 bps rate hike by the Federal Reserve was almost taken from granted well ahead of the meeting. When the Fed finally issued its statement late on 02nd November, there was little surprise about the 75 bps rate hike. However, there were two contradictory signals coming from the Fed. On the one hand, the Fed appeared to be relentless in its pursuit of slamming down inflation by hiking rates. On the other hand, the Fed also indicated that December onwards may see muted rate hikes. The bottom line is that the terminal rates are now well above 5% and that is a worry.

Let us look at the rate hikes in retrospect. If one includes the latest rate hike of 75 bps on 02nd November, the rates have now scaled up to the range of 3.75% to 4.00%. Since the rate hike saga started in March 2022, Fed has hiked rates by 375 basis points, out of which the last 4 Fed meets hiked rates by 75 bps each. For the first time, the Fed gave a clear indication that it may have been too conservative in the past about envisaging the terminal rates. Now the Fed is also veering towards a terminal Fed Funds rate in the range of 5.00% to 5.50%. We will look at this point in greater detail in the CME Fedwatch probability cluster.

On the positive side, the US GDP showed a turnaround in the September quarter, growing at +2.6% after 2 consecutive quarters of negative growth. However, that may be a little premature since the third quarter positive GDP growth was largely a function of reduced trade deficit. At the same time, the housing investments lagged even as the consumption spending was much lower than anticipated. What the Fed is betting on is that some growth impact may still be there and possibly even a hard landing may happen. However, the Fed is confident that the risk of a large scale growth contraction may still be averted.

Fedwatch cluster hints at rates going up to 5.00% to 5.50%

An interesting tool to analyst the future trajectory of the rates is to look at the probability of rate hikes through the Fed Fund futures trading. Remember, this is derived from the market based trading and hence is not a theoretical indicator but more of a practical indicator. Currently, the rates are at the range of 3.75% to 4.00% and the Fed Fund futures indicate that the most likely range is the cluster of between 4.75% and 5.50%, with a greater bias at the upper end of the trajectory. That means, we still have a good amount of hawkishness yet to be implemented by the Fed, assuming that the growth levers don’t get damaged.

Data source: CME Fedwatch

What do we gather from the cluster table probabilities above? Here are 2 takeaways.

    • Fed is hinting at another 50 bps rate hike in December with an outside probability of 75 bps. However, it must be remembered that the neutral rate in the US is 2.50% and we are already 150 bps above that. From this point, every 25 bps rate hike will start to hurt growth in a rather intense and pernicious way.

    • At the end of the day, everything will depend on how inflation pans out between now and December. More than the headline consumer inflation, the Fed would be watching out for the food and core inflation. If the core inflation and food inflation remain sticky, the Fed may front-load 75 bps in December also. 

For the time being, the Fed is not done with its rate hikes, nor with its overtly hawkish stance on the monetary front. It has stated that it would relentlessly pursue rate hikes till inflation came to 2% or shows that inflation is in a decisive journey towards 2%. That is ambiguous, but that is the best we can get from the Fed for now. 

Three things that struck us about the Fed statement

Amidst the jargon and the sophistry in the Fed language, there are 3 things that stood out and are really worth a mention here.
    a) Powell hinted that he was willing to take the rates to a sufficiently restrictive level; which could mean 250-300 bps above  neutral rate of 2.5%. That is likely to put a lot of pressure in high frequency growth indicators in the US in the next few months.

    b) One redeeming feature that gives hope to the markets is the rather cryptic statement that the FOMC would take into account the cumulative tightening of monetary policy. Whether this holistic picture would also mean factoring in the impact on other countries is not clear, but the Fed can merely remain dollar obsessed.

    c) Jerome Powell sounded less than confident about a soft landing, one of his trademarks statements of intent till now. However, Powell has expressed the hope that the Fed would be able to tweak rates without pushing the US into contraction.

Read more: Fed maintains its aggressive tone while raising rates by 75 basis points

Does the Fed meet outcome change the India narrative? We have to await the decision of the RBI MPC post the special meeting on 03rd November. Whether the RBI chooses to restrict itself merely to debating on inflation failure or it also chooses to act on the Fed action remains to be seen. The inflation story is well known and there is not much to debate. Economies the world over are struggling to tackle inflation and it would naïve to expect that India would be any different. Perhaps, the meeting may give us some clarity on whether the RBI also plans to go the whole hog on hawkishness. We have to wait.