Fed watchers stick finger in the air and see rate spike above 5%

(Bloomberg) – Federal Reserve Chairman Jerome Powell’s statement that peak interest rates will need to be higher than previously thought has caused Wall Street to make its best guess at this final level. .

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The Federal Open Market Committee estimated in September to reach a target range of 4.5% to 4.75% in 2023. But Powell, citing high inflation and a very tight labor market, told reporters on Wednesday that “data inflows since our last meeting suggest that the ultimate level of interest rates will be higher than expected.

He spoke after authorities raised rates by 75 basis points for the fourth consecutive time to a range of 3.75% to 4%, extending the central bank’s most aggressive tightening campaign in years. 1980.

Four Fed policymakers who have spoken since the meeting also flagged a higher rate without giving a specific forecast. Richmond Fed President Thomas Barkin told CNBC on Friday that it is “entirely conceivable” that the central bank will have to raise rates above 5%, although that is not the current plan. .

With little beyond Powell’s remarks and Wednesday’s Fed statement, economists at Nomura Holdings Inc. after the meeting raised their estimate of where rates will peak in a range of 5.5. % to 5.75%. Others reaffirmed projections that were 5% or more next year.

Powell said the goal was to be “tightly enough” to bring inflation back to the Fed’s 2% target. One way is to set rates above inflation or inflation expectations, although it has included several ways of measuring underlying inflation or inflation expectations.

“I don’t have a hard number for you” on how to measure inflation, he said.

Core prices in the United States, which exclude food and energy, rose 5.1% in the 12 months to September, according to the Fed’s preferred indicator.

“Our view on the terminal rate is more of a finger guess than high science,” said Jonathan Millar, senior economist at Barclays Plc in New York.

Millar estimates the final rate to be between 5% and 5.25%, while stressing that there is a high level of uncertainty. “The lack of clarity reflects the fact that they don’t have much conviction in any of the standard approaches, which has led them to a more ad hoc approach which is judgmental in nature,” he said.

Powell also spoke of the need to cool the US labor market.

The October jobs report, released on Friday, showed only slight progress in this direction. Businesses increased hiring last month by 261,000 more than expected and average hourly earnings accelerated from September, while unemployment hit 3.7%.

“We still see a tight labor market and wage pressures are still quite high,” said Lydia Boussour, senior economist at EY Parthenon, who expects a terminal rate of 4.5% to 4.75%. “The Fed must continue.”

In separate remarks on Friday, Boston Fed President Susan Collins said her view of peak rates had risen since September, but “I really think it’s premature to be too specific about what it might look like because things are still evolving.”

Minneapolis Fed Chief Neel Kashkari told The Associated Press he plans to issue a higher peak rate forecast next year than he did in September, while declining to clarify that figure now. And Chicago Fed Chairman Charles Evans told Reuters he expects the Fed to eventually raise rates “slightly higher” than the September projections.

Economists polled by Bloomberg ahead of the meeting were forecasting a terminal rate of 5%. Investors are betting that the Fed will hike 50 basis points in December and peak around 5.1% by mid-2023.

What Bloomberg Economics says…

“Powell sent a clear message to the markets at the November 2 FOMC meeting: Don’t expect us to keep raising rates 75 basis points every time, but we’re not pivoting either. accommodating. We expect the Fed to slow the pace of rate hikes to 50 basis points at the December meeting and release a new dot chart showing a terminal rate of around 5%.”

— Anna Wong, Andrew Husby and Eliza Winger (economists)

The FOMC, in its “dot plot” projections, revised up its view of the highest rate at each of the three quarterly forecasts this year in response to inflation continuing to beat forecasts. There will be two consumer price reports ahead of the December FOMC decision, including the October data released on November 10.

Powell used his post-meeting press conference to shift the focus from the size of the next hike, which has been a central focus for Wall Street, to rates peaking higher and staying there long enough to calm. inflation.

“The problem going forward is bringing rates to a plateau, be relatively confident that’s restrictive,” said Vincent Reinhart, chief economist at Dreyfus and Mellon, who puts the terminal rate between 5% and 5%. .25%. “So keep the funds rate firm for as long as it takes until you’re confident that inflation is about to return to target.”

A standard way to assess the positive real rates Powell desires would be rates above the expected inflation over the coming year, which would be 5% using the estimate for the coming year from the University of Michigan survey, or about 3.5% for 2023 core inflation, excluding food and energy, as measured by professional economists’ forecasts.

“So that would mean the real funds rate is around zero or even still negative,” said Jonathan Wright, an economics professor at Johns Hopkins University. “And that would mean he still has a long way to go to get to the restrictive position that is needed.”

–With help from Craig Torres, Jonnelle Marte and Vince Golle.

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Carol N. Valencia