US interest rates highest since 2008

• The continued ‘front-loading’ of large interest rate hikes is in response to soaring inflationary pressures. The Fed’s preferred inflation measure – the core personal consumption expenditure (PCE) deflator – rose by 0.5 per cent in September to an annual growth rate of 5.1 per cent, well above the Fed’s 2 per cent inflation target. And when released next week, core inflation – which excludes volatile food and energy prices – is expected to lift by 0.5 per cent in October with the annual pace of 6.6 per cent steady at the highest level since August 1982.
• Indeed, the stickiness of core inflation is proving to be a headache for policymakers, with prices of essential goods, such as children’s clothing, auto repair costs, motor insurance, medical care goods, public transportation, communication and rent, continuing to lift. In fact, prices of medical care (+6.0 percent), household furnishings and operations (+9.3 percent), new vehicles (+9.4 percent) and used cars and trucks (+7.2 percent) have all skyrocketed over the year to September.
• And the cost of shelter – or owner’s equivalent rent costs – something the Fed has little control over – has surged 6.6 per cent over the past year, accounting for over 40 per cent of the total increase in core prices. The slow change in sticky prices is feeding into consumer and business expectations about future inflation, helping inflation to become self-perpetuating.
• In fact, in the latest University of Michigan consumer confidence survey in October, US long-term inflation expectations picked-up in a concerning development for the Fed as it tries to keep price views in-check. Consumers expect prices to climb at an annual rate of 2.9 per cent over the next five to ten years and 5 per cent over the next year.
• Also supporting the US inflationary pulse has been an extraordinarily tight labour market. The US unemployment rate remains anchored at 3.5 per cent – the lowest level since 1969 – and job vacancies unexpectedly rose in September, suggesting that labour demand, while slowing, is still robust. Labour costs rose solidly in the September quarter, as employers continued to boost wages to attract and retain talent, with wage pressures boosting overall inflation.
• In today’s policy statement, Fed policymakers continued to acknowledge that inflation remained too high: “Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.” Adding, that the central bank is “highly attentive to inflation risks,” and “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” 

What about the Fed’s policy pivot?

• While US inflation remains uncomfortably high, there are some early signs of an easing in price pressures, following rapid rate increases. According to the latest National Federation for Independent Business (NFIB) small business optimism survey, the proportion of companies looking to raise their prices in the next three months eased from 32 per cent to 31 per cent in September 2022, the smallest share since January 2021.
• Other data has showed US manufacturing activity grew at its slowest pace in nearly 2½ years in October as rising interest rates cool demand for goods.
• The interest rate sensitive housing market has also hit the brakes. With US mortgage rates topping 7 per cent for the first time in more than two decades, mortgage applications have fallen to the lowest level since 1997, according to the Mortgage Bankers Association (MBA). And home prices in 20 large US cities slid 1.3 per cent in August 2022, the most since March 2009, according to the S&P CoreLogic Case-Shiller index.
• The US economy rebounded in the September quarter with gross domestic product (GDP) expanding by a 2.6 per cent annualised rate after contracting in the two previous quarters. But the underlying data was weaker with personal consumption, the biggest part of the US economy, lifting at a modest 1.4 per cent pace, slowing from the June quarter.
• Overall, it suggests that weakening consumer demand, the deteriorating economic outlook and rising inventory levels are making businesses more cautious and suggests pricing power is waning. If so, this indicates inflation could slow through the first half of 2023.
• The weaker economic activity data combined with a recent Wall Street Journal article by Fed “insider” Nick Timiraos – hinting that some officials are concerned about the pace of rate hikes – had opened the possibility of a smaller 50 basis point rate hike in December. And the recent dialling-back of rate hikes by both the Bank of Canada and Reserve Bank of Australia added to market expectations ahead of the November meeting that the Fed may rein in its policy aggressiveness.
• The Fed statement on Wednesday noted that, “the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments” when “determining the pace of future increases in the target range.”
• The comment can be viewed as a potential signal that the Fed is leaning toward slowing the pace of tightening to 50 basis points at its December 13-14, 2022 meeting. And in his press conference Fed Chair Powell said it would be appropriate to slow the pace of increases “at some point,” and “that time is coming and may come as soon as the next meeting or the one after that.” But he cautioned that the size of future rate hikes remains largely dependent on the direction of incoming economic data – especially consumer prices – with a pledge to continue fighting inflation. And added, “the ultimate level of interest rates will be higher than previously expected.”

Policy detail and forward guidance 

• As widely expected, the US Federal Reserve unanimously increased its target range for the federal funds rate by 75 basis points for a fourth straight meeting to a near 15-year high of 3.75-4.00 per cent.  
• The US central bank has raised rates at its last six meetings beginning in March 2022, marking the fastest round of increases since former Fed Chair Paul Volcker’s fight to control inflation in the 1970s and 1980s.
• No new forecasts were released at the meeting with the next meeting scheduled for December 13-14, 2022. Fed forecasts in September implied a 50 basis point move in the December meeting, according to the median projection. Those projections showed the federal funds rate lifting to 4.4 per cent this year and 4.6 per cent next year. But economists surveyed by Bloomberg in late October saw rates peaking at 5 per cent next year.
• On inflation: The Fed’s statement said officials remained “highly attentive to inflation risks,” opening the door to further hikes.
• On the economy and labour market: On the economy, the Fed noted, “Recent indicators point to modest growth in spending and production” with still “robust” job gains and “low” unemployment.
• On rate hikes and forward guidance: Notably, the November statement said that “ongoing increases” will still be needed to bring interest rates to a level that are “sufficiently restrictive to return inflation to 2 per cent over time.” But also noted that policymaker’s are considering the “cumulative” impact of its hikes so far. And his press conference, Fed Chair Powell said, “incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.”
• On the potential slowing pace of rate hikes: In his press conference, Fed Chair Powell said it would be appropriate to slow the pace of increases “at some point,“ and “that time is coming and may come as soon as the next meeting or the one after that. No decision has been made.” He also stressed that, “we still have some ways” before rates were tight enough.   
• On the Fed balance sheet: Fed officials said they will continue to reduce their holdings of US Treasuries and mortgage-backed securities, as planned, a pace amounting to about US$1.1 trillion a year.

US financial markets reaction 

•  Ahead of the Fed meeting, US sharemarkets rallied in October, with the Dow Jones index posting its biggest monthly percentage gain since January 1976 (+14 per cent) on expectations of a slowdown in rate hikes and a better-than-expected corporate earnings season.
• US sharemarkets were volatile on Wednesday, briefly lifting when Fed Chair Jerome Powell said that a slower pace of rate hikes could come as soon as December. But stocks moved sharply lower after Powell said the central bank has “some ways to go,” adding that it is premature to think about pausing rate hikes as rates could peak at higher levels than previously thought.
• The Dow Jones index traded in a 932-point range before ending Wednesday lower by 505 points or 1.6 per cent. The S&P 500 index fell by 2.5 per cent and the Nasdaq index fell by 366 points or 3.4 per cent.
• US treasuries ended Wednesday lower (yields higher) after erasing gains sparked by the Fed’s policy statement, which suggested a slower pace of tightening might be warranted soon. But the market reversed course during Fed Chair Powell’s press conference, in which he emphasised that the terminal rate is likely to be higher than previously expected, and that over-tightening is preferable to under-tightening. At the close of US trade, the US 10-year yield rose by 4 points to near 4.10 per cent and the US 2-year yield lifted by 7 points to near 4.61 per cent.
• Major currencies were volatile against the US dollar in European and US trade. The US dollar fell broadly against major currencies on Wednesday after the Fed signalled that future interest rate increases to battle high inflation could be made in smaller increments. But later in the session the US dollar lifted following comments from Fed Chair Powell that he expected the terminal rate to be higher than previously expected at September’s meeting.
• The Euro rose from near US$0.9860 to US$0.9975 but was lower near US$0.9815 at the US close. The Aussie dollar rose from near US64.00 cents to highs near US64.90 cents but was lower near US63.50 cents at the US close. The Japanese yen rose from 147.70 yen per US dollar to JPY145.75 but was lower near JPY147.85 at US close.
• The Australian share market looks set to end its winning streak on Thursday following a volatile night on Wall Street. According to the latest SPI futures, the ASX 200 index is expected to open the day 113 points or 1.6 per cent lower this morning.

Commonwealth Bank (CBA) Group forecasts

• Commonwealth Bank (CBA) Group economists expect further monetary policy tightening from the Fed, but with some moderation in the pace. We expect a 50 basis point move on December 14, 2022 before a final 25 basis point move on February 1, 2023 to a peak in the fed funds target rate of 4.5‑4.75 per cent. The risk remains for a faster pace and higher peak, depending on incoming data.