Another Fed jumbo rate hike is expected next week and then life gets difficult for Powell

First the easy part.

Economists widely expect the Federal Reserve to approve the fourth straight jumbo interest rate rise at its meeting next week. The three quarters of one percentage point hike would bring the central bank’s benchmark rate up to a level of 3.75%- 4%.

“The November decision is a lock. Well I would be floored if they didn’t go 75 basis points” said Jonathan Pingle, chief U.S. economist at UBS.

The Fed decision will come at 2 p.m. on Wednesday after two days of talks.

What happens at Fed Chairman Jerome Powell’s press conference a half-hour later will be more fraught.

The focus will be on whether Powell gives a signal to the market about plans for a smaller rise in its benchmark interest rate in December.

The Fed’s “dot-plot” projection of interest rates, released in September, already penciled in a slowdown to a half-point rate hike in December, followed by a quarter-point hike early in 2023.

The market is expecting signals for a change in policy and many think Powell will use his press conference to hint that a slower pace of interest rate rises is coming.

A Wall Street Journal story last week that said some Fed officials are not keen to keep hiking rates by 75 basis points per meeting. That , alongside San Francisco Fed President Mary Daly’s comment that the Fed needs to start talking about slowing down the pace of hikes, were taken as a sign of a slowdown to come by the stock and bond markets.

“No one wants to be late for the pivot party, so the hint was enough,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Luke Tilley, chief economist at Wilmington Trust, thinks that Powell will signal a smaller rate hike in December by focusing on some of the good wage inflation news that was published earlier Friday.

There was a clear slowdown in private sector wage growth, Tilley said.

See: U.S. third-quarter wage pressures cool a little from elevated levels

But the problem with Powell signaling he has found an exit ramp from the jumbo rate hikes this year is that his committee members might not be ready to signal a downshift, Pingle of UBS said.

He argued that the inflation data writ large in September won’t give Fed officials any confidence that a cooling in press pressures is in the offing.

See: U.S. inflation still running hot, key PCE price gauge shows

Another worry for Powell is the future data might not cooperate.

There are two employment reports and two consumer price inflation reports before the next Fed policy meeting on Dec. 13-14.

So Powell might have to reverse course.

“If you pre-commit and the data slaps you in the head – then you can’t follow through,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

This has been the Fed’s pattern all year, Stanley noted. It was only in March that the Fed thought its terminal rate, or the peak benchmark rate, wouldn’t rise above 3%.

While the Fed may want to slow down the pace of rate hikes, it doesn’t want the market to take a downshift in the size of rate rises as a signal that a rate cut is in the offing anytime soon.

But some analysts believe talk about the first cut will come soon after the Fed reduces the size of its rate rises.

In general terms, the Fed wants financial conditions to stay restrictive in order to squeeze the life out of inflation.

Pingle expects Kansas City Fed President Esther George to formally dissent in favor of a slower pace of rate hikes.

There is growing disagreement among economists about the “peak” or “terminal rate” of this hiking cycle. The Fed has penciled in a terminal rate in the range of 4.5%-4.75%.

Some economists think the terminal rate could be lower and others who think that rates will go above 5%.

Those who think the Fed will stop short of 5% tend to talk about a recession and the Fed fast pace of hikes “breaking something.” Those who see rates above 5% think that inflation will be much more persistent.

Ultimately, Stanley thinks that the data isn’t going to be the deciding factor.

“The answer to the question of what either forces or allows the Fed to stop is probably not going to come from the data. The answer is going to be that the Fed has a number in mind to pause,” he said.

The Fed “is careening toward this moment of truth where it has very tight labor markets and very high inflation and the Fed is going to come out and say ‘okay, we’re ready to pause here’.”

“That strikes me that is going to be a very volatile period for the market,” he added.

Fed fund futures markets are already volatile with traders penciling in a terminal rate above 5% two weeks ago and now seeing a 4.85% terminal rate.

Over the month of October, the yield on the 10-year Treasury note
TMUBMUSD10Y,
4.008%

rose steadily this month above 4.2% before softening to 4% in recent days.

“When you get close to the end, every move really counts,” Stanley said.

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