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Fed again raises interest rate: How far can it go?

ICICIdirect Research 03 Feb 2023 DISCLAIMER

What's Buzzing 

Moderating inflation has enabled the Fed to reduce the pace of rate hike. 


The US Federal Reserve raised its interest rate by 25 bps taking range between 4.50% to 4.75% and signalled its intention to keep raising them possibly in smaller increments. By raising quarter percentage point it has taken it to the level last seen in 2007. Additionally, FOMC also continued with its tightening of balance sheet as announced in May 2022. 

Our Perspective: 

We expect the US Federal Reserve to go for one more rate hike of 25 bps in the March meeting taking it to 5% before pausing as it takes time for the full effects of those increases to ripple through the economy. We believe the Fed may change its stance considering weakening economic conditions and may look at the possibility of cutting rates in the later part of 2023.

Moreover, yields are tumbling in anticipation that the Fed will take a back seat soon and pause on tightening plans as inflation continued to ease. The cumulative effect of last year’s aggressive rate hike has been slowing the economy as most economic parameters like housing, manufacturing and consumer spending have started showing weakness. US 10 year as well as two-year yields are declining since November. US treasury yield curve, the gap between yields on 10-year and two-year treasury note inverted at -70 bps suggesting looming recession. It supports our view of pause in rate hike in the first half and possible rate cut in the second half of the year.

However, the jobs data remains strong despite economic slowdown. The unemployment rate remained at a 50-year low and wage inflation is still on a higher trajectory. We believe that weakening of jobs data may act as a final deterrent for the Fed to pause its rate hike cycle. We have already witnessed moderation in wages and salaries growth. We believe in coming months, it will provide further comfort to the central bank.

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