Two More Rate Hikes Left From Fed, According To Markets

The Federal Reserve (Fed) doesn’t see a rate cuts in 2023, according to recent minutes. Yet the markets forecast peak rates as soon as spring. Markets currently view the most likely path as two more small hikes, specifically, a 0.25 percentage point hike on February 1, and a similar 0.25 percentage point hike on March 22. The Fed doesn’t plan to end hikes quite so soon, based on recent projections.

Fed Forecasts

At the Fed’s December meeting policy-makers released forecasts for the level of rates in 2023 via the Fed’s Summary of Economic Projections. Only two of nineteen Fed policy-makers saw rates remaining under 5% in 2023. The base case for markets is currently more of an edge case for the Fed.

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In contrast, markets, as summarized by the CME FedWatch Tool, expect that rates may not exceed 5% at all, and if they do, any period of over 5% rates may be brief. Based on December projections, the Fed sees at least one more hike than the markets do, maybe two.

The markets and the Fed are not too misaligned in expectations currently, but markets do see peak rates coming in at 0.25-0.5 percentage points below where the Fed suspects they may peak.

Inflation Data

The difference in rate expectations could come down to inflation projections. The markets may suspect that inflation reports will continue to be favorable over the coming months. The Fed would, of course, be happy with that too, but have repeatedly emphasized that they need to see more evidence that inflation is truly returning to the 2% level, rather than just trending down from recent high levels. The Fed also wants to see wage growth cool and more evidence that mark-ups by businesses are coming down. As such the markets may see a continued run of encouraging inflation reports and related data coming, that the Fed is not yet willing to speculate on.

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Recession Risk

The bigger concern is recession. The Fed sees a soft landing for the economy this interest rate cycle as most likely. That may be optimistic. Many economic indicators point to a 2023 recession, though the jobs market does continue to hold up remarkably well.

As such, the other major scenario that could cause the current forecasts of the Fed and market expectations to converge is a recession. A recession may bring down inflation, but also encourage the Fed to bring down rates to help spur economic growth.

Peak Interest Rates

The Fed and markets both suspect peak rates for the U.S. economy are getting close. However, the Fed sees broadly sees one or two more hikes than the market does in 2023 currently taking rates materially over 5%, whereas markets aren’t sure rates will exceed 5%.

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Optimistically, that may be because inflation data will trend better than the Fed currently anticipates. However, more pessimistically, there’s a risk that the difference between the forecasts is recession risk. A 2023 recession may force the Fed’s hand in necessitating a rate cut. Either way, both the markets and Fed policy-makers believe we’re close to peak rates on a six-month view.