Interest Rates Still Expected to be Raised for 2023

Markets anticipate that the US Federal Reserve (Fed) will raise interest rates again on February 1, 2023, most likely by 0.25 percentage points to 4.5%-4.75%. However, there is a good likelihood the Fed will choose a higher 0.5 percentage point increase. The Fed’s decision in February is the first of eight scheduled meetings to determine interest rates in 2023.

Concerns About Inflation

Due to inflation concerns, markets expect the Fed to continue raising rates in early 2023. According to recent data, inflation in the United States is decreasing. After exceeding a 9% annual rate in June, CPI inflation in November was 7%. Nonetheless, the Fed believes that the recent drop in the inflation rate is insufficient.

The Fed wants inflation to return to its 2% target, and while inflation is dropping, it is still high in absolute terms, and there is a risk that inflation will not fall all the way to 2%. For example, the Fed is concerned that wage growth of roughly 6% will continue to keep service inflation high, even though housing and commodities costs are forecast to be lower in 2023. Another risk is that an unforeseen economic shock, such as the Ukraine crisis or supply chain disruption, drives inflation back up.

A Stable Job Market

Because the rest of the US economy did relatively well, the Fed was able to be so focused on combatting inflation with higher rates in 2022.

Unemployment in the United States is expected to be between 3.5% and 4% in 2022, which is low by historical standards. The Fed is concerned that rising interest rates will precipitate a recession in the United States. However, the reasonably robust labor market has meant that the Fed hasn’t been too concerned about the consequences of high-interest rates from its inflation fight.

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Yes, house values have recently fallen, and both the stock and bond markets have had fragile 2022s, but these aren’t the Fed’s primary concerns. The Fed’s mandate is to keep inflation under control while maintaining strong employment. With employment generally healthy, the Fed can fight inflation without too many trade-offs, at least for the time being.

Incoming Information

Based on the Fed’s previous pronouncements, a rate hike in February appears likely; nevertheless, December inflation statistics will be revealed in January, informing the Fed’s outlook. CPI inflation for December 2022, for example, will be released on January 12, while unemployment for December will be announced on January 6. This data is unlikely to influence the Fed’s February stance, but it may alter the path of interest rates at the March and May meetings.

The Rates Path in 2023

Later 2022 meetings witnessed recurrent and significant rises in interest rates. Markets currently predict a few minor boosts earlier in the year, but rates might remain stable for much of 2023 or decline.

Markets believe that the Fed’s final raise of the current interest-rate cycle will occur in March. However, this would necessitate ongoing good news regarding lowering inflation and possibly some cooling in the labor market. Nonetheless, the Fed is presently committed to keeping rates high in 2023, so even if rates aren’t raised after March, the Fed may keep rates high for most of 2023. Unfortunately, a U.S. recession is the only thing that could change that and cut rates.

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