Expect two Fed rate hikes this year, said Fitch Ratings recently.
The credit rating agency also predicted four Fed rate hikes in 2023 -- and these six Fed rate hikes will take the Fed funds rate (upper bound) to 1.75% by the end-2023 from 0.25% currently.
Fitch said its updated US interest rate forecasts reflect the major pivot by the Fed at its policy meeting on 14-15 December 2021, prompted by evidence that inflation is broadening and underscored by the meeting minutes.
The previous forecasts (a single 25bp rate rise in 2022 and two in 2023) would have taken the upper bound to 1% at end-2023, Fitch noted, adding that these forecasts, published in our Global Economic Outlook on 7 December 2021, pre-dated the Fed’s meeting, in which it signalled that net asset purchases will probably cease in March 2022, and markedly changed its language on inflation.
According to Fitch, the Fed described inflation as having exceeded 2% ‘for some time’, suggesting that recent increases have already compensated for earlier shortfalls under the Fed’s flexible average inflation targeting (FAIT) strategy announced in mid-2020.
FAIT does not formally define the period over which inflation should average 2%.
The minutes indicate that most Federal Open Market Committee (FOMC) participants think the condition of maximum employment — a criterion for raising rates alongside price stability set under earlier forward guidance — will likely be achieved relatively soon, Fitch pointed out.
In addition, the Fed is now characterising inflation as a potential threat to a sustained economic recovery and emphasising the need to anchor expectations to avoid sharper policy tightening, later on, the firm said.
Higher-than-expected inflation outturns and rising wage growth and services inflation (including rental inflation) have raised Fed concerns that inflation is broadening beyond the pandemic-related goods price shock, potentially warranting earlier or faster rate rises, Fitch observed.
Meanwhile, continuing labour shortages amplify the risk of further increases in wage growth, the firm added.
Recent data showed the US labour force participation rate was unchanged at 61.9% in December 2021, while the unemployment rate had dropped to 3.9%.
“We believe this year’s rate rises will come at the Fed’s June and September policy meetings,” Fitch predicted. “The omicron variant may delay the advent of maximum employment ahead of the March meeting. Our calculations suggest US payrolls are still about 2 million below this level.”
The interval between ceasing net asset purchases and raising policy rates will be much shorter than in 2014-2015, Fitch estimated.
December’s ‘DOT plot’ showed a median expectation among FOMC members of three rate rises this year but does not constitute formal forward guidance.
The move to unanimity on the need for a rate rise in 2022, from a 50-50 split at September 2021’s policy meeting, was arguably more significant, Fitch pointed out.
Fitch has not changed its US or global GDP forecasts from December’s Global Economic Outlook.
“We think the private sector is relatively well prepared for higher US borrowing costs, but our updated forecasts reinforce the prospects for higher US Treasury yields and a stronger US dollar against the euro and the Chinese yuan,” the firm noted.
Despite increases in recent weeks, real yields on inflation-protected bonds remain historically low, the firm said.
“We think full normalisation could see US nominal interest rates rise to about 3% over the medium-to-long term, potentially pushing up global rates,” Fitch predicted.