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The Fed is sure to announce on Wednesday that it will raise interest rates again. But investors are hopeful that the increase will be less than the previous four hikes.
Traders bet on an increase of only half a point. CME Fed Funds futures show an 80% probability of upside by half a point.
The Fed has raised interest rates by three quarters of a percentage point in the past four meetings (June, July, September and November). This followed two small price increases earlier this year. The central bank’s main short-term interest rate, which was at zero at the start of the year, is now between 3.75% and 4%.
The hope is that inflation pressures are finally starting to abate enough that the Fed can focus – the Fed talks about a series of small rate hikes – to avoid the economy collapsing into recession.
But it may not be that simple. The government reported on Friday that the main measure of wholesale prices, the producer price index, rose 7.4% in the 12 months through November. That was slightly above the expected rate of 7.2% but a marked slowdown from the 8% increase through October.
The widely watched consumer price index data for November is released on Tuesday, just a day before the Federal Reserve’s announcement. The Consumer Price Index rose 7.7% year-on-year through October.
As long as inflation remains an issue, the Fed will have to tread carefully.
“Inflation may have peaked, but it may not be dropping as quickly as people would like,” said Cathy Jones, senior fixed income analyst at the Schwab Center for Financial Research.
Jones still thinks the Fed will only raise interest rates by half a point this week and may look to raise them by just a quarter point in early 2023. But she conceded that the Fed is now kind of “making it as it goes.”
The other problem: The Fed’s rate hikes this year have had limited impact on the economy so far. Yes, mortgage rates have skyrocketed which has severely hurt housing demand, but the job market is still strong. Wages are increasing, and consumers are still spending. It cannot continue indefinitely.
“The cumulative effect of higher rates is just beginning. And then the Fed has to slow down a little bit,” Jones said.
So investors will need to pay attention not only to what the Fed says in its policy statement on interest rates and what Powell talks about in his press conference. The Fed will also release its latest forecasts for GDP growth, the labor market and consumer prices on Wednesday.
In September, the Fed’s projections called for GDP growth of 1.2% in 2023, an unemployment rate of 4.4% and an increase in personal consumption expenditures, the Fed’s preferred measure of inflation, of 2.8%. It seems likely that the Fed will lower its GDP target and raise its forecasts for the unemployment rate and consumer prices.
The possibility of an economic downturn is growing, and the Fed’s forecasts may reflect that. But the Fed is not expected to start cutting rates until 2024 at the earliest, so it may be too late for the central bank to prevent a recession.
“A pivot or pause is not a cure-all for this market,” said Keith Lerner, chief investment officer at Truist Advisory Services. Cuts in interest rates may be too late. Recession risks are still relatively high.”
The US economy is not in recession yet. But are American shoppers being left out? We’ll get a better idea on Thursday after the government releases retail sales figures for November.
Economists are actually expecting a slight 0.1% decline in retail sales from October. But it is important to put this number in context. Retail sales increased by 1.3% compared to September and 8.3% over the past twelve months.
So it’s possible that consumers may have simply started holiday shopping. Inflation affects the numbers as well, with retail sales being (positively) affected by the fact that people are having to spend more money on things.
A market strategist also pointed out that as long as price increases continue to slow, consumers will feel more confident as well.
Everyone has been talking about inflation this year. “Going forward, it will be more about bringing down inflation in 2023 or 2024,” said Arnaud Cosserat, CEO of Comgest Global Investors.
What does that mean for investors? Kosirat said people should look for high-quality consumer companies that still have pricing power and can maintain their profit margins. He said two stocks owned by his company fit that bill: luxury goods maker Hermès (HESAF) and cosmetics giant L’Oréal (LRLCF).
Monday: UK monthly GDP; Oracle (ORCL) Earnings
Tuesday: US consumer price index; Economic sentiments in Germany
Wednesday: Fed meeting EU industrial production; UK inflation Earnings from Lennar (LEN) and Trip.com (TCOM)
Thursday: US Retail Sales; US Weekly Unemployment Claims; interest rate decisions of the European Central Bank and Bank of England; Jubail (JBL) Profits
Friday: Eurozone PMI; UK retail earnings from Accenture (ACN), Darden Restaurants (DRI) and Winnebago (WGO)
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