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Federal Reserve Chairman Jerome Powell speaks to press in Washington following the last Federal Open Market Committee on interest rate policy on November 2. The committee is meeting again this week. Photo: Reuters
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

Markets are holding out for a Fed policy pivot in 2023

  • As the Federal Reserve prepares to unveil its latest policy direction, investors are hoping for a smaller interest rate rise than those of recent months
  • If delivered, it would be a promising sign that the Fed is shifting focus from fighting inflation to keeping jobs and growth buoyant in 2023
David Brown
David Brown
Why you can trust SCMP
We will know at the end of the two-day Federal Open Market Committee (FOMC) meeting on Wednesday whether the US Federal Reserve is intent on keeping up the pressure on inflation, or whether the much-vaunted Fed policy pivot has finally arrived. The market’s money is on a 0.5 percentage rise in the Fed funds rate this week after four straight 0.75 percentage jumbo hikes.
If this happens, it will be an encouraging sign that the US monetary tightening cycle could end sometime in 2023. It could be a game changer, not only for global interest rate expectations, but for risk perceptions generally.
The Fed’s inflation fight may not be quite over yet, but it could light the touch paper for stocks and bonds and for currency markets as the strong US dollar continues to lose momentum. There’s a lot depending on the Fed this week and it’s time to deliver some better news for markets.

The key question is whether inflation or growth is the key driver for Fed policy right now. Inflation expectations may not be falling away as quickly as some might like in the US, but it’s worries about the outlook for recovery and jobs which should dominate in 2023, with the Fed keeping a cautious eye on the chances of the US economy getting stuck below optimum output potential for rather longer than it would choose.

Shoppers in San Francisco, US, on November 29. Photo: Bloomberg
Consumer confidence and business optimism are flagging, the economy has already briefly dipped into a shallow two-quarter technical recession in the first half of 2022 and all the signs suggest that the worst of the inflation peak has already passed. It’s time for the Fed to move on and recalibrate policy for a different set of circumstances.
Headline consumer price inflation looks like it topped out at 9.1 per cent in June and it should be heading back towards 3 per cent by the end of 2023, especially if global energy and commodity prices continue to soften. The Fed’s own preferred inflation measure, annual core personal consumer expenditure prices, seems to be behaving much better, moderating down to 5 per cent in October which should be a comfort.

Also, the implied five-year forward inflation expectations rate derived from the US Treasury curve has stabilised at 2.2 per cent, in line with the Fed’s 2 per cent inflation goal. It all suggests that the worst of the 2022 inflation scare is over.

Labour market will determine when US Fed stops raising interest rates

The FOMC’s economic projections, which will be issued this week alongside its rate policy decision, should provide some further clues to the Fed’s thinking and whether inflation angst is giving way to greater concerns about the outlook for jobs and growth. In September’s projections, the Fed was anticipating 2023 growth coming down to 1.2 per cent, unemployment rising to 4.4 per cent and inflation easing to 2.8 per cent.

If FOMC projections published this week emphasise more sluggish recovery, weaker job prospects and easier inflation risks, it should be clear that the script has changed and the Fed’s monetary thrust could be changing for the better.

A relatively less hawkish tone from the Fed should be cathartic for US interest rate expectations. US money market futures have been anticipating the Fed funds rate peaking at 5 per cent early next year from the current 4 per cent, implying two further half-percentage-point moves before the Fed’s tightening cycle comes to an end.

With inflation likely to ease next year, the Fed is expected to bring the funds rate back down to 4.5 per cent towards end-2023, with an implied target range of around 3 to 4 per cent from 2024 onwards. This would be in line with a return to a more “normal” level of policy rates, consistent with sustainable, long-run US growth potential at 2 per cent coupled with a 2 per cent inflation target.

The Fed holds the whip hand for global interest rate expectations, so a positive outcome this week should be good news for world financial markets generally. The reduced risk of runaway US interest rate hikes should also help to dampen the rampant US dollar, providing extra scope for relief rallies for other currencies such as the euro and China’s yuan.

Hopefully this week should be confirmation that we have turned the corner and the end is nigh for the Fed’s inflation angst.

David Brown is the chief executive of New View Economics

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