MNI FED WATCH: Slowing To 50BPs With Further Hikes In 2023

The Federal Reserve is set to raise interest rates a half-point Wednesday to the highest since 2007 with investors focused on how much additional tightening will be needed early next year to get inflation back towards 2%.

The slower pace of increase after four straight 75-bp hikes has been well telegraphed by Fed Chair Jerome Powell and will take the fed funds target range to 4.25%-4.5% from near-zero just nine months earlier. It comes as consumer inflation as measured by the CPI eased to 7.1% in November after peaking at 9.1% in June and core CPI slowed to 6% from a high of 6.6% in September.

FOMC projections for the rates path are expected to be revised higher once more as data on economic activity and the labor market remained resilient. Former Fed officials told MNI the fed funds rate is likely to breach 5% in the first half of 2023 and stay higher for longer than markets now expect. Investors are also pricing in about 50 bps of rate cuts by the end of 2023.

The longer elevated inflation numbers persist, the greater the chance the Fed could overdo it and cause an unnecessarily deep recession. Powell and others officials have stated their willingness to overtighten, while the Fed's credibility is at risk if it trims rates before seeing concrete evidence that inflation is heading downward.

SOFT LANDING HOPE

Price pressures for service sectors outside of housing remain high -- a top concern for Fed officials in 2023. Labor shortages and wage growth are fueling household income and spending, which are in turn sustaining job gains and wage pressures.

Elsewhere there is better news. In the goods sector, price pressures have dissipated as supply bottlenecks eased. For housing as well, the Fed has good reasons to believe shelter inflation will turn down.

The FOMC would like to see a cooling in labor demand, as measured by job openings and quits data, initial jobless claims and slower payroll gains. However, wage pressures may stay strong absent a recovery in workforce participation, some economists say, and that could keep a second straight 50-bp hike on the table for February.

A best-case scenario, in which the Fed slows the economy and reins in prices without putting millions out of work, may still be possible, Powell said this month.