The Fed is coming to the end of the cycle

The Federal Reserve System (FRS) slowed down the pace of key rate hike to 0.25 percentage points, setting it at 4.5-4.75% per annum and noting the weakening of inflationary pressure in the US. This slowdown is a sign of the end of the current Fed tightening cycle. However, the head of the regulator, Jerome Powell, says that “further work” is needed and the restrictive policy will likely remain after the peak rates have been reached.

The Open Market Committee of the US Federal Reserve on Wednesday again raised the key rate, but this time by only 0.25 percentage points (p.p.) – to the level of 4.5-4.75% (this is the maximum since October 2007) .

Thus, the regulator actually moved to the end of the current cycle of monetary tightening, which began in March last year.

In total, during this time, the Fed raised rates by 4.5 percentage points (including in June, July, September and November, the rate was increased by 0.75 percentage points, in December – by 0.5 percentage points. ), which was the most pronounced cycle of policy tightening since the 1980s.

A statement following the meeting noted that current US figures point to “modest growth” in consumption and production, while unemployment remains low. The wording on inflation was softened – the regulator indicated that price growth “weakened somewhat”, although it is at elevated levels (earlier, the Fed also noted imbalances in supply and demand and high energy prices). The regulator once again noted that “Russia’s invasion of Ukraine and related events create additional pressure on inflation and on global economic activity.” The Fed also retained the wording that “further rate hikes are warranted” and tightening is necessary to achieve “enough restrictive” monetary policy that would bring inflation back to the 2% target over time. Assessing the pace of future rate hikes, the regulator will start from an assessment of the cumulative impact of monetary tightening, as well as take into account delays in the transfer of higher rates to the real economy, inflation and the state of the economy.

The scatter chart with the forecasts of the committee members, published in December (next time it will be presented following the results of the March meeting), assumed an increase in the rate in 2023 to 5–5.25%, however, market participants doubt the Fed’s ability to bring rates to such a level and expect an increase only in March.

The head of the regulator, Jerome Powell, commenting on the results of the meeting, noted that the Fed still has “further work” to do – the committee members consider it appropriate to further increase the rate, but after reaching the peak level, “it will be necessary to maintain a restrictive policy for some time.”

Inflation, meanwhile, has already slowed to 6.5% in annual terms (monthly growth in December was negative – minus 0.1%). Core inflation (excluding energy and food) in annual terms fell from 6% to 5.7%, but grew by 0.3% month on month. The consumer spending deflator, which the Fed is targeting, slowed to 5% in December from 5.5% in November, while the base figure fell to 4.4% after 4.7% in November. Earlier, the Fed indicated the need to wait for the labor market to cool down (Jerome Powell also said that the labor market is not yet balanced), but the increase in wages in the fourth quarter has already slowed to 1% against 1.2% in the third. In December, 223,000 jobs were created and the unemployment rate slowed to 3.5%.

Some indicators also point to a slowdown in activity – for example, the Purchasing Managers’ Index (ISM) in the industry in January fell to 47.4 points compared to 48.4 points in December (including the sub-index of new orders – from 45.1 points up to 42.5 points). Capital Economics predicts that in the first quarter, year-on-year GDP growth may decline by 1.5% – experts do not exclude the possibility of a mild recession in the first half of the year. The Fed’s forecast foresees growth this year by only 1.2% (the International Monetary Fund gave a more positive assessment of 1.4% the day before), but in the fourth quarter, US GDP on an annualized basis (that is, if it changed at the same pace throughout the year) grew by 2.9%, which is higher than expected.

Experts expect the Fed to make no more than one or two rate hikes and keep it at the current level until the targets are reached.

Capital Economics expects that the rate will be raised by only 0.25 percentage points against the background of an additional slowdown in inflation. Andrey Kulakov, head of the fixed income analysis department at Gazprombank, notes that the Fed has not yet given a benchmark for the final level of the rate in this cycle of increases, but the shift in emphasis indicates an early end to the cycle. Natalya Milchakova, a leading analyst at Freedom Finance Global, expects the rate hike to end at about 5.5%, while lowering US interest rates can be expected no earlier than 2024.

Tatyana Edovina