With the Federal Reserve’s first Federal Open Market Committee (FOMC) meeting of the new year just a week away, the stakes couldn’t be higher. Will the next Fed rate hike be the last in 2023?
Well, maybe. Analysts and economists around the world are increasingly confident that a Fed-induced recession will hit the country within a year. Indeed, many believe that the central bank has tightened the economy a bit too quickly.
While metrics such as unemployment have generally held up despite a broader deterioration, jobs are also set to decline, likely sooner rather than later. Many believe that curbing hikes may be the best way to avoid a devastating economic downturn. As we approach what could be the last hike of the year, economists are keeping a close eye on the magnitude of the rate hike. They are also keeping tabs on comments from Fed officials on the direction of the economy this year.
However, not everyone agrees on next week’s meeting. According to a recent Reuters poll, most economists predict there will be at least one more rate hike in the first quarter before the Fed turns off the gas.
Currently, most market projections point to the Fed announcing a quarter-point rate hike on Feb. 1, the smallest hike in recent memory. This was reaffirmed in the same Reuters survey; 80% of economists surveyed expect a 25 basis point hike, bringing the federal funds rate to between 4.5% and 4.75%. This is certainly far from the benchmark rate of 0% that the country enjoyed at the start of 2022, but is it enough to bring inflation down?
Fed rate hike looms as recession fears grow
At its last policy meeting in December, Fed officials unanimously agreed that slowing the pace of rate hikes was best to achieve the much-prophesied “soft landing.” At the meeting, officials acknowledged the balance between trying to reduce aggregate demand enough to reduce inflation while not burdening the economy with runaway unemployment that weighs too heavily on low-income demographics.
Some are even hoping for a real Fed pivot – that the Fed will reverse course and lower rates at some point this year. At its December meeting, however, it became clear that no Fed official favored a cut in the federal funds rate in 2023, especially without a noticeable reduction in prices.
However, not everyone agrees with this assessment. Paul Ashworth, Chief North American Economist at Capital Economics, believes that lower rates are a virtual inevitability this year:
“Our view is still that the rapid slowdown in inflation, combined with a noticeable decline in job growth, will change the landscape quite dramatically in the first half of this year. […] After a final tightening of 50 (basis points) in the first quarter, bringing the fed funds rate to a high of nearly 5%, we still expect the Fed to cut rates again before the end of the month. This year.
Now, Fed pivots and recession projections are intrinsically linked. Indeed, why would the central bank seek to lower rates without having a clear prerogative to do so? Mass unemployment and declining consumer spending would certainly be seen as a valid cause.
Layoffs are already underway, led by high-growth technology and financial companies. Unemployment is currently expected to reach 4.8% over the next two years. Although nowhere near as devastating as past recessions, this still represents potentially millions of job cuts.
What’s the missing piece to ending rate hikes once and for all?
At the end of the day, the central bank will not stop its tightening process until inflation has made a clear progress towards the target level of 2%. In this regard, there are still inlays to meet the Fed’s higher price targets.
According to the latest consumer price index (), things are improving, but not at the pace that many would like. The December CPI report, released earlier in January, showed a monthly decline in prices of 0.1%. Meanwhile, year after year ( ) inflation fell to 6.5%, a far cry from last summer’s peak of 9.1%. Core inflation (excluding food and energy) also increased significantly, up 0.3% in December and 5.7% over the past year. This is, by all accounts, a promising sign that prices are starting to reign.
However, things like unemployment – which has remained particularly high in 2022 – have yet to catch on. Persistent unemployment, however, is not a new phenomenon. As long as unemployment remains low, the risk of a wage-price spiral is high.
Wendy Edelberg of the Hamilton Project thinks unemployment will have to rise to reach the level of inflation accepted by the Fed:
“What I’m very confident about is that we can’t continue to see employment gains of over 200,000 every month. Given our population, given the number of people who want to work, that’s just not where we’re going to go.
As of the date of publication, Shrey Dua does not hold (either directly or indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.