Since the last monetary policy decision in the US, the Federal Reserve has received enough data to support a new slowdown in the cycle of high interest rates: in December, the Fed committee decided to raise interest rates by 50 basis points , after four consecutive increases of 75 bps. That is, the analysis according to which directors will opt for a 0.25% hike is almost unanimous. But on the horizon of analysts, the expectation of a start of cuts is still far away. The reason is the unclear signals of the effect of the more restrictive policy on activity.
For those who believe the end of the bull cycle is near, the 0.1% decline in the consumer price index (CPI) in December is already a clear indication that the worst is over in terms of price escalations. In the same month, the core consumer spending index (PCE) increased by 0.3%, with a sharp decline in goods, but still pressure on services.
The 0.2% decline in US consumer spending also points to an expected slowdown, as well as a likely turnaround in the upward trend in wages, from 4.8% to 4.6% in November-December – the annualized quarterly change was down to 4.13%, according to calculation by ASA Investments.
But there are also indications that the economic slowdown is at an even slower pace than expected by the FOMC. In the labor market, for example, the December paycheck still showed the creation of 223,000 jobs. And last week it was reported that US gross domestic product (GDP) grew at an annual rate of 2.9% in the fourth quarter of 2022, down from 3.2%% in the third quarter, but at above estimates. .
For Goldman Sachs, data on wage growth and inflation are encouraging, while signals on business growth have been mixed and, at times, worrying. This also facilitates the reduction of the pace of interest rate hikes, but is insufficient, according to the investment bank, to anticipate the movements of the FOMC throughout 2023.
The most probable, according to the bank, is that the monetary authority will continue to seek a growth path below potential, in order to rebalance the labor market so that inflation returns to 2% in a sustainable manner. “We agree with Fed officials that there is still a long way to go. After all, the gap between jobs and workers is still about 3 million above its pre-pandemic level,” Goldman Sachs warned.
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The bank’s initial projection is that the Fed still needs to push for two more 25 basis point hikes at its March and May meetings. But a smaller dose of interest could follow if weak business confidence continues to dampen hiring and investment. On the other hand, medicine could be more bitter if it re-accelerates as the impact of past policy tightening fades.
For manager Galapagos Capital, reducing the pace of interest rate hikes to 25 bps is already a consensus, but the discussion on the terminal rate will continue to evolve in upcoming meetings. When the “time comes”, the Fed will announce a pause, leaving the door open for further rate hikes. “Our view is that it would be a mistake for the FOMC to prematurely close the cycle or consider interest rate cuts in 2023 to avoid ‘passive tightening,’” economists say in a report.
For the Galapagos, the idea of a “soft landing” in the US economy contradicts the assumption of a rapid decline in inflation and an early end to the Fed’s tightening cycle. soft landing’, then market prices look even more inappropriate,” they argue.
The manager assesses that the composition of inflation remains a concern, given that the trend in full inflation has been modest and occurred only at the end of 2022, when it closed at 6.5%, compared to 7% in the 2021. And this late drop was mostly due to a 40% drop in gasoline prices between July and December.
Another indicator of price strength, according to Galapagos, was core inflation, which ended 2022 at 5.7%, not far below 2021’s 6%. core inflation for goods, but core inflation for basic services told a different story. At 7% annually, this basic services inflation in 2022 was higher than it was in 2021, when it ended at 6.8%.
For Galapgos, the source of the high inflation of basic services derives precisely from the tense conditions of the labor market and the rapid growth of wages. “In our view, it is still an open question whether essential services will experience a marked slowdown by the end of this year. Wages must steadily decelerate from 3.5% to 4% and unemployment must rise above 5% to meet two conditions necessary to control inflation in basic services,” the report said.
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The manager says she continues to believe the Fed’s policy is to aim for a real interest rate of around 1.5%, which implies around 100 basis points. remaining in the bull cycle. “We strongly disagree with the market price, which includes a lower terminal rate than the Fed and 50 basis points. of cuts in 2023”.
Rodrigo Cohen, an investment analyst and co-founder of Escola de Investimentos, says attention needs to be paid to the FOMC’s statement, which should be more “dovish” as the US has shown signs of declining economic activity.
He also highlighted the latest data on the decline in consumption, industrial production and inflation and also recalled that the GDP in the 4th quarter was lower than in the previous period and increased the duration and a recession in the country, even if mild. “All of these factors contribute to not raising interest rates as much. And the committee is expected to address all of these factors in the release.
In addition to the decision, statement and interview with Chairman Jerome Powell this Wednesday, Cohen recalled that the ADP’s National Report on Employment and Payroll will still be released on Friday and that this will be important in helping understand next steps of the Fed.
“The lower the average hourly earnings, the lower the chances of inflation because Americans who earn less buy less. If we have indicators pointing to controlled inflation, we could have a next high, of 25 points, and then we can expect the interest rate to stay in the next few meetings until the down cycle starts.”
And the end of the cycle?
Andressa Durão, economist at ASA Investments, believes the FOMC statement should acknowledge slowing inflation, but despite the dovish bias, there is no indication that the end of the cycle is near. “The ‘forward guidance’ should be maintained and, in the press conference, Powell should reinforce the message that monetary policy could remain at a tight level for a while.”
Ariane Benedito, economist at Esh Capital, also believes that not even market optimism with the PCE result released last week should change the Fed’s current stance. This is due to core indicators and labor market data, which remain resilient.
“If the US central bank adopts 0.25% in this week’s meeting, which is the market consensus today, the interest rate extension is imminent and there will still be room for another readjustment of the same magnitude in the next meeting (March), with the rate remaining at 5% for 2023. So far, I see no room for easing US monetary policy”.
Raphael Camargo, an analyst at Neo Investimentos, is another who believes that today’s movement of the monetary policy committee has already been “telegraphed” in the latest communications from its members. For him, the downward trajectory of the price index is not yet fully established. “The FOMC will also have to contend with a still quite tight labor market and wages running at high levels. The most recent data indicate still incipient moderation,” he said.
For him, the announcement of the decision shouldn’t have major changes compared to the one released last December and should highlight the maintenance of the “guidance” according to which new maximums will be appropriate to reach sufficiently restrictive levels.
Julius Baer economist David Meier wrote in a report this week that given last week’s GDP data, residential investment has slowed, reflecting the first headwinds of tighter monetary policy. “The drop in interest rate sensitive assets confirms that the Fed’s monetary policy can be viewed as restrictive. Going forward, it will become more difficult to justify further hikes and we tend to expect some scaling back in March.”
Felipe Reymond Simões, economist and director of WIT Asset, believes that a 0.25% hike today would be a very good indication that the Fed is indeed slowing the pace of interest rates and should probably stop at 5.5% annually.
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“Which is generally good for the world, because it’s an indication that they are comfortable with the current level of inflation and that this rate is already sufficient to contain the rise in inflation. It’s good because the US interest rate is the benchmark. It will be a signal that other central banks may also start trimming the hike. In the case of Brazil, which is towards the end of the cycle, perhaps even starting to lower interest rates.
For the BofA, although the Fed appears to favor another reduction in the pace of rate hikes, the communication during the interim period suggests that policy makers have not changed their view on where the rate is likely to go, or view that inflationary pressures will ease slowly.
According to the report, even with the expected reduction in pace, the Fed will want to avoid the interpretation that this implies a lower terminal rate or earlier initiation of cuts than the committee saw fit the last time it met in December.
“This means that there is no change in interest rate guidance in the FOMC statement. We believe the statement will continue to say that “continued increases in target range will be appropriate.” A softening of this language could lead to an unwelcome easing of financial conditions.”
For Global X Chief Investment Officer Jon Maier, stocks and Treasuries have already rallied this month on widespread expectation that the Federal Reserve is nearing the end of its interest rate hikes as inflation eases. eases and tighter financial conditions cool the economy.
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