Investors now expect the Federal Reserve to raise interest rates to 5 percent next year, indicating that it will need to rein in the economy more difficult than expected to tackle high inflation.
According to futures markets that track the federal funds rate, traders priced the entire benchmark policy rate as high as 5 percent in May 2023, up from 4.6 percent before the latest inflation data released late last week.
Expectations rose after that September A CPI report that showed an alarming acceleration in monthly price pressures across a wide range of everyday items and services.
Bigger-than-expected jump in consumer price growth Everything but guaranteed The Fed will again opt for a significant rate hike at its next policy meeting in early November and will present a fourth straight 0.75 percentage point hike, its prospects fully priced in the market.
That would raise the federal funds rate to a new target range of 3.75 percent to 4 percent, well above the near-zero level recently recorded in March and close to the policy peak rate of 4.6 percent set by most officials. in September.
The higher inflation numbers, along with additional signs of labor market resilience, also fueled fears of an extension of the 0.75 percentage point pace through December, with another half point rate hike expected for February.
Can the markets push it higher? “Absolutely,” said Edward El-Husseini, senior interest rate analyst at Columbia Threadneedle. “But we are also at a point where the Federal Reserve may be at risk of not being able to meet market expectations,” he added, citing concerns about financial stability.
To slow the pace of interest rate increases, Fed officials said they need to see signs that inflation is beginning to ease on a monthly basis. To consider a pause in the historically aggressive tightening campaign, the central bank said it needed to see substantial evidence that “core” inflation – which strips out volatile items such as food and energy – was falling toward its long-term 2 per cent target.
Officials said the plan was to raise interest rates to a level that would effectively constrain the economy and keep them there for a long time. Jay Powell, the president, warned last month that high rates rise and the longer they stay at restrictive levels, the greater the economic pain.
Patrick Harker, president of the Philadelphia Federal Reserve, said Thursday he supports the Fed’s pause after interest rates hit a restrictive level in order to assess the economy, adding that he sees funds “much higher” than 4 percent by the end of 2022.
“Then, if we have to, we can tighten up even more, based on the data,” he said in a speech. But we must let the system work by itself. And we also need to realize that this will take some time: inflation is known to take off like a rocket and then go down like a feather.”
On Wednesday, Neil Kashkari, president of the Minneapolis Federal Reserve and a voting member of the Federal Open Market Committee next year, emphasized that the standard is high for the Fed to adjust course.
“If we don’t see progress in core inflation or core inflation, I don’t understand why I would advocate a stop at 4.5 percent, or 4.75 percent or something like that,” he said on a panel. “We need to see actual progress in core inflation and service inflation and we’re not seeing it yet.”
The move in interest rate expectations came after both Canada and the UK reported earlier this week that consumer prices rose more than expected in September. “This is a global story. Inflation figures in Canada and the UK were surprisingly to the upside. It is the dynamics of global inflation that is driving the US yield higher this week,” said Subhadra Rajappa, head of US interest rate strategy at Société Générale.