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Khatija Haque - Head of Research & Chief Economist
Published Date: 01 November 2022
The focus this week is squarely on the US Federal Reserve’s policy announcement on Wednesday 2 November. The FOMC is expected to raise the Fed Funds rate by 75bp for the third consecutive time, taking the upper bound to 4%, the highest since 2007.
At the start of this year, few analysts could have predicted the size and speed of the Fed’s rate hikes in 2022. Indeed, on 3 January 2022, Fed Funds futures predicted just 75bp in rate hikes for the whole of this year. But the surge in inflation – partly due to the commodity price shocks following Russia’s invasion of Ukraine in February – has forced the Fed to move much more aggressively in terms of monetary policy tightening.
The US economy has, however, been surprisingly resilient in the face of 300bp of rate hikes as well as rising consumer prices. The first estimate of Q3 GDP came in above market expectations at 2.6% quarter-on-quarter annualized and showed robust – albeit slowing – growth in personal consumption. Households continued to spend on goods and services through September even as the prices of those goods and services rose at the fastest pace in over 40 years.
The strength of consumer spending is likely due to the strength of the labour market – unemployment is at a 30-year low and both jobs and wage growth have consistently exceeded expectations this year. Spending has probably also been supported by stronger household balance sheets after consumers paid down credit cards and built up savings during the pandemic. While credit card debt has increased this year, it remains below Q4 2019 levels.
With the US economy still growing at a solid rate, and unemployment well below 4%, there is plenty of room for the Fed to continue to raise rates to curb inflation, which remains stubbornly high. Headline CPI eased to 8.2% y/y in September from a 2022-peak of 9.1% in June but core inflation (which excludes food and energy) accelerated to 6.6% in September – more than three times the Fed’s 2% target – on higher housing, transportation and medical care costs.
Nevertheless, the S&P 500 rallied around 8% in October as markets anticipated a slowdown in the pace of Fed rate hikes. Recent survey data has pointed to softness in output both in manufacturing and services as well as indications that the labour market may be turning. Some Fed officials have also indicated that the central bank may need to move forward with rate hikes in smaller increments, given the time lags between policy changes and their impact on the real economy.
Markets also took heart from the Bank of Canada’s smaller than expected rate hike and the ECB’s “dovish hike” last week, which suggested that global central banks may be closer to the end of their hiking cycles than the start. As such, Fed Chair Jerome Powell’s comments post the FOMC meeting may be more important for the market than the 75bp the Committee is likely to deliver.
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