Investors and traders all over the world will be alert in the coming days ahead of the Fed’s announcement this coming Wednesday (at 20:00 Israel time). According to market estimates, minutes of meetings and statements made by its senior executives, the Fed will raise interest rates by only 25 basis points. Against the background of the macro data, the Fed will of course also have to take into account the war in Ukraine and its various consequences, (the sharp rise in commodity prices, for example).
The Fed’s Open Markets Committee meeting will take place this week, after high inflation figures were released in the US last week. The consumer price index rose 0.8% in February, in line with expectations. In the last 12 months, the CPI rose by 7.9% – compared 7.5% in January.
Guy Beit Or, Psagot’s chief economist, notes that this week the markets should get more clarity about the Fed’s direction after a long period of speculation that the war has only intensified. “If we start from the bottom line, the Fed is expected to raise interest rates by 0.25% and reflect a more aggressive set of forecasts with at least 5 interest rate hikes this year and another four next year. In addition, after completing the quantitative easing process Start in the middle of the year. “
At least as of today, after another volatile week, “Although the markets lowered interest rates by 50 basis points (0.5%) in the decision this coming Wednesday, they embody a more aggressive pad later on. B. And looking at the coming year more than 7 interest rate hikes, which will bring the effective Fed interest rate to a level of 1.9% already in February 2023
According to him, two factors supported a resurgence in bond yields and interest rate pricing over the past week: The first, was the ECB (European Central Bank) interest rate decision which was surprising and more aggressive than expected. The ECB understands that the economic downturn and the spike in inflation are inevitable short-term events. Will increase the risk of inflationary spin. Or perform their basic function and is to control inflation. True, monetary tightening into an economic crisis can only intensify the damage to aggregate demand, but the choice here is between two not simple options and only one of them the central bank maintains credibility, and stabilizes The long expectations.
“The second factor was inflation data in the United States which continue to signal widespread price pressures and this even before the inevitable effects of the war.”
So war on the one hand, monetary tightening on the other, what do the markets mean?
In our view, writes Beit Or, “the Fed will indeed be more aggressive in the coming months and it is quite likely that in the coming months we will see interest rate increases of 50 basis points per meeting. However, we estimate that the Fed will not reach interest rates We estimated that the US would experience a hit to aggregate demand due to high inflation, erosion in wages and disposable income, low consumer confidence and due to what we define as saturation in private consumption after years of high spending. All the war is doing is only to increase inflation on the one hand, and bring about a significant damage to the aggregate demand in the world on the other hand in a way that will affect all countries and of course the United States as well.
“What we are trying to say here is that while the Fed will be very aggressive, we estimate that the weakness of the economic data will start to be much clearer in the data starting in the summer months where we also expect to see a gradual decline in annual inflation due to last year’s. “It is low, but we cautiously estimate that the balance of inflationary risks against the impact on economic activity will begin to change, which will lead the Fed to halt the cycle of interest rate hikes towards the end of the year.”
“In the coming months, the high volatility of the stock markets is expected to continue, which continues to justify a more defensive approach. Our assessment is that the Fed will complete the cycle of raising interest rates earlier than expected and supports long-term fluctuations in the nominal channels abroad as well as in Israel.
“There is a relatively high chance of an interest rate increase of 0.5%”
Alex Zabrzynski, Meitav Dash’s chief economist, estimates in his weekly review that “there is a relatively high chance of an interest rate increase of 0.5% this week. Only the war may cause the Fed to settle for 0.25% in the meantime. This is because the actual inflation rate continues to accelerate; a record rate of small businesses reports rising prices; according to the relationship between the survey and the inflation rate, there is a high chance that in the coming months US inflation will double-digit; Inflation expectations in the University of Michigan’s sentiment survey have jumped to the highest level since 1981; “Inflation expectations embedded in the bond market have risen sharply and expectations for all ranges, including 30 years, are significantly higher than the 2% target.”
Futures contracts now reflect that the Fed is expected to raise interest rates to 1.7% by the end of 2022 and to 2.25% by the end of 2023. In his estimation, “interest rates are expected to rise beyond these levels.”
“The experience of the 1970s with the two waves of inflation following a rise in the price of oil shows that a more negative real interest rate (a gap between the interest rate and the actual inflation rate) provides poor results on both the inflation front and growth. The first wave of inflation peaked in 1974. They tried not to hurt growth and kept interest rates at an average of 3% below inflation. As a result of this policy, growth in these years averaged 1.8% and inflation about 11%. Which led to an average growth of about 2.4% and inflation of about 9.5%. In the same cycle or slightly above it. In our estimation, this time the Fed’s interest rate with a fairly high probability will reach at least 2.5%, which also marks the target for 10-year bonds. ”