The Fed has no other choice: a 75bp Fed Funds hike is the minimum requirement

Comments by Franck Dixmier ahead of the FOMC meeting on 20 and 21 September, 2022

• We expect a 75bp rate hike at the next FOMC meeting, and cannot rule out an even bigger move of 100bp
• Faced with inflation that is increasingly spreading to the economy, the Fed has no choice but to go beyond the normalisation of its monetary policy and the neutral rate
• Given the recent upward correction in bond yields and market expectations, this meeting is not expected to cause any major surprises for the markets.

At the Jackson Hole symposium in August, US Federal Reserve Chairman Jerome Powell delivered a very firm message about the Fed's absolute determination to fight inflation. Since then, inflation has again surprised on the upside, with the CPI at +8.3%[1] over one year in August, against +8.1% expected; and the core CPI is still rising at +6.3% against 6.1% expected (+5.9% in July).

With these figures, the Fed has solid arguments to pursue its strategy of rapid and significant rate adjustments. Faced with a rise in prices that continues to spread through the economy, the Fed is increasingly forced to go beyond the simple normalisation of its monetary policy, which would involve setting rates at a neutral level, and to consider a more restrictive policy.

By acting quickly and strongly, the Fed’s objective is clear: to weigh on demand and employment in order to break the wage-price spiral and put inflation on a path compatible with its price stability objective of +2%. It will keep rates high until it is confident of this path, even if it means adjusting rates downwards later if the economic environment deteriorates significantly. For the time being, the US economy is resilient, despite advanced signs of a slowdown and a correction in the housing market. The ISM[2] manufacturing index came in at 52.8 in August, unchanged from July, and growth in the service sector accelerated last month, with the ISM services index rising 0.2 points to 56.9 last month from 55.4. US households are drawing on their savings to support consumption.

We therefore expect a 75bp increase at the next FOMC meeting. However, given that the Fed will not meet in October, we do not rule out an even bigger move, of 100bp. This forecast is within the consensus, with the market expecting 75bp at 70% and 100bp at 30%[3].

The Fed's updated expectations on the future path of Fed Funds ("dots") should signal Fed Funds above 4% by the end of 2023. Given the recent upward correction in bond yields and market expectations that would validate a Fed Funds peak between 4.25 and 4.50% in Q2 2023, this meeting should not cause any major surprises for the markets.

[1]  Source : Bureau of Labor Statistics

[2]  Source : Institute for Supply Management

[3] source : World Interest Rate Probability, Bloomberg, 14/09/22

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