How much will the US Federal Reserve raise interest rates?

Of course, the answer depends on how fast it reliably pulls back. There are many indications that we are now in the early phase of post-peak inflation. This is also confirmed by the November inflation figures published today. Markets are also cautiously optimistic that inflation has peaked, but despite this binary approach, the outlook remains murky at best.

The interest-sensitive rate, which is often used as a benchmark for the Fed’s interest rate, remains in a trading range of around 4.0% to 4.5%. This corridor appears to be the top of this cycle, and only a surprisingly sharp rise in prices in the coming months is likely to push these yields to new highs.

The spread between the 2-year yield and the Fed funds rate remains near annual lows. As you can see from the chart below, the market continues to price in a more likely rate hike cycle to reverse or reverse as we have already seen most of the rate hikes and the central bank is now slowing monetary tightening.

Fed funds futures agree. Before today’s monetary policy decision, there is more than a 70% chance of a 50 basis point rate hike. It would be the first softer interest rate hike since the central bank began a 75 basis point rate hike in March.

The debate now turns to how to slow and stop rate hikes. “The easy part is already gone,” said Vincent Reinhart, chief economist at Dreyfus & Mellon and a former chief economist at the Fed.

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The decision to raise interest rates has not raised monetary policy concerns so far this year. When the Fed started raising rates in March, its range was 0% to 0.25%. Core PCE inflation, the Fed’s preferred measure of price pressures, topped 5% per year at the same time. So the difference between interest and inflation was huge. Assuming the Fed raises rates today by 50 basis points to between 4.25% and 4.50%, rates would still be slightly below PCE core inflation (5.0% in October).

However, how things will continue is far from clear. Much depends on how the Fed defines clear signs that inflation has peaked and, more importantly, signs of slowing. The challenge now is that the Fed has not yet clarified what numbers it will use to target inflation, and will likely do so gradually.

Callie Cox, investment analyst at US broker eToro, said:

Powell made it clear that interest rates could remain high for some time. While the Fed’s flexibility is encouraging, the high-yield environment is not the easiest to invest in. Until inflation comes down, it can. a little more time, and a recession cannot be completely ruled out.”

The key variables that will determine what happens next are obvious: inflation, economic activity, and market pricing in the lead-up to a rate hike. The uncertainty comes from how the feedback of these variables will develop.

At best, the assumptions are that inflation has peaked, that the Fed will slow down and stop raising interest rates, and that economic growth will slow, perhaps to a mild and brief recession, but not a deeper one. Surprises on any of these fronts can dramatically turn the picture on its head, leaving the crowd waiting to see if and when the butterfly flaps its wings.

The level is almost the same as before the pandemic

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