Following the recent decision by the US central bank to maintain interest rates, investors are now eagerly awaiting two potential rate hikes that could push the federal funds rate to 5.6% by the end of this year, representing a 50 basis points (bps) increase from its current level. Predictions from CME's Fedwatch tool indicate a 25bps rise during the upcoming Federal Open Market Committee (FOMC) meeting scheduled for July 25 and 26.
In a pause after ten consecutive rate hikes since March 2022, the US Federal Reserve chose to hold steady in June but acknowledged the likelihood of further increases in 2023. Federal Reserve Chair Jerome Powell stated that "almost all committee participants believe that some additional rate increases will be appropriate this year." Presently, the federal funds rate stands at a 16-year peak, and although there was no change in June, the impact of the previous ten hikes is evident among market participants.
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| Federal funds rate as of June 20, 2023, according to the Federal Reserve Bank of New York. |
Despite inflation in the US decelerating for eleven consecutive months, it remains elevated at 4%. Meanwhile, the interest rate for a 30-year mortgage ranges between 6.99% and 7.14%, with an average nationwide rate of 7.08%. This implies that borrowers would need to pay $660 to $685 per month in interest for every $100,000 borrowed. If the federal funds rate increases by an additional 50bps through two more rate hikes, it is likely to push lending rates higher, tightening credit conditions in the US.
During the press conference following the last FOMC meeting, Powell mentioned that the board members did not reach a consensus on the July meeting. "We didn't make a decision about July," Powell informed reporters last Wednesday. He further added, "I do expect that it will be a live meeting. It may make sense for rates to move higher but at a more moderate pace, but we have made no decision about a hike or pause at the July meeting."
Despite earlier expectations of a potential rate cut, most market analysts do not anticipate a reduction in rates this year. Asawari Sathe, Vanguard's senior economist, expressed doubt about the possibility of a federal funds rate reduction in 2023. "We believe inflation will continue to moderate but remain above 3% through year-end, and unemployment will trend higher to a still reasonable 4.5%," wrote the Vanguard economist. Vanguard's machine learning prediction tool also suggests that rate cuts are not expected until the following year. Sathe added, "Vanguard's model anticipates that the Fed won't be in a position to cut rates until the middle of 2024."
CME's Fedwatch currently shows a 76.9% probability of a 25bps rate increase at the upcoming July FOMC meeting. Approximately 23.1% of market participants expect no change, with the rate remaining unchanged at 5% to 5.25%. If the threshold of 5.6% is reached within this year, it will surpass the Federal Reserve's previous prediction from March by a significant 50bps.
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| CME Fedwatch tool as of June 20, 2023. |
However, as May drew to a close, several economists began suggesting a potential shift in the central bank's approach. "Chair Powell right now does not want to talk about reducing rates," shared Ian Shepherdson, chief economist at Pantheon Macroeconomics, with his clients last month. Shepherdson further commented, "But that will change; the Fed will do what the data tell them to do, and the data are heading south."
