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Fed set for another 75-basis-point rate hike; early pivot unlikely

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The Federal Reserve will deliver another 75-basis-point interest rate hike next week and likely hold its policy rate steady for an extended period once it eventually peaks, according to a Reuters poll of economists released on Tuesday.

Policymakers have done little to push back on market pricing for a third consecutive rate hike of three-quarters of a percentage point at the US central bank’s Sept. 20-21 meeting, with inflation, as measured by the Fed’s preferred gauge, running at more than three times its 2 per cent target.

A strong majority of economists, 44 of 72, predicted the central bank would hike its fed funds rate by 75 basis points next week after two such moves in June and July, compared to only 20 per cent who said so just a month ago.

If realized, that would take the policy rate to the 3.00 per cent-3.25 per cent target range, the highest since early 2008, before the worst of the global financial crisis. The remaining 39 per cent still expected a 50-basis-point hike.

The shift in expectations for the larger hike has pushed the dollar to a two-decade high against a basket of currencies. The US currency was forecast to extend its dominance for the remainder of this year and into early next.

“If there has been a shift in the Fed’s tone in recent months, it has been in the direction of a stronger commitment to reducing inflation, even at the risk of a downturn,” noted Michael Gapen, chief US economist at Bank of America Securities, who was among those polled.

Like many others in the poll, Gapen recently changed his forecast to show the Fed hiking rates by 75 basis points next week instead of half of a percentage point.

But raising borrowing costs so quickly comes with its own risks. The poll put the probability of a US recession over the coming year at 45 per cent, unchanged from the previous forecast, with the chance of one occurring over the next two years rising to 55 per cent from 50 per cent.

The world’s No. 1 economy, which has seen its gross domestic product contract in the past two quarters, was expected to grow below its long-term average trend of 2 per cent until at least 2025, according to the poll.

Economists said the interest rate outlook for the September meeting could change if inflation drops. The US Labor Department is due to release consumer price index data on Tuesday, with economists polled by Reuters forecasting the CPI would rise 8.1 per cent in the 12 months through August. The CPI jumped 8.5 per cent in the 12 months through July.

Whether or not the Fed slows its monetary tightening, either through a 50- or 25-basis-point hike at its Nov. 1-2 policy meeting, is on a knife’s edge, the poll showed. A majority of the economists, however, expected the central bank to opt for a 25-basis-point hike at its Dec. 13-14 meeting.

There was still no consensus among economists on where and when the Fed will stop hiking rates, and similarly there was no consensus on when it would start cutting them.

Among the economists who had a view through the end of 2023, 47 per cent forecast at least one rate cut, down from 57 per cent in a poll last month.

Once the fed funds rate reaches a peak, the central bank is more likely to leave it unchanged for an extended period rather than cut it quickly, according to more than 80 per cent of respondents who answered an additional question.

Fed Chair Jerome Powell has said he and his fellow policymakers will raise rates as high as needed and would keep them there “for some time” to bring inflation down to the 2 per cent target.

“We just don’t see the Fed cutting rates next year, it would be too soon. They won’t have enough evidence inflation is on a sustained downward course towards the target,” said Sal Guatieri, senior economist at BMO Capital Markets, who also was among those polled.

‘WISHFUL THINKING’

While inflation, as measured by CPI, was forecast to average 8.0 per cent and 3.7 per cent this year and in 2023, respectively, a tight labor market was expected to underpin price pressures, according to the poll.

The US jobless rate, which rose to 3.7 per cent in August from 3.5 per cent in July, was forecast to average 3.7 per cent this year before climbing to 4.2 per cent in 2023 and 2024.

However, the unemployment rate needs to go significantly higher to bring inflation down to 2 per cent, according to 16 of 30 respondents to an additional question who gave a median jobless rate of 5 per cent. The other 14 said it did not need to rise significantly.

“The claim wage pressures can be reduced … without substantially increasing unemployment is wishful thinking on the Fed’s part,” said Philip Marey, senior US strategist at Rabobank, who was among those polled.

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