Qatar National Bank (QNB) predicts that the US Federal Reserve (the central bank) will continue raising interest rates throughout 2023 and maintain its monetary tightening policies to curb inflation.
In its weekly report, the bank suggests that it is premature for the US Federal Reserve to declare victory in its battle against soaring inflation, despite the bold rate hikes undertaken so far and the substantial gains in moderating inflation levels.
The report speculates that energy production constraints and supply chain headwinds, coupled with the rapid performance of the US economy, may alter the inflation trajectory in the short or medium term.
“The US Federal Reserve (Fed) has been on the move to revert a decade-long approach of ultra-easy monetary policy since March last year, when untamed inflation forced it to increase policy rates for the first time in more than three years. This marked the beginning of one of the most dramatic and unexpected monetary tightening cycles in US history,” the report states.
After a brief pause in interest rate hikes following the June meeting of the Federal Open Market Committee (FOMC), the Federal Reserve decided to increase rates again at its most recent meeting last month. The latest action represents the 11th increase in interest rates during this cycle, including the aggressive 75 basis points hikes during the second half of 2022. This adds up to a total of 525 basis points of hikes, bringing the Fed funds policy rate to 5.25-5.5%, its highest level in more than 20 years.
The report notes that the Federal Reserve has been moderating the pace of its tightening cycle since December 2022, with milder rate hikes and even a pause in June. However, uncertainty still lingers. There is an ongoing debate about whether the Federal Reserve is prepared to scale down, pause for an extended period, or pivot its policy rate changes earlier than expected in early 2024.
Recent inflation data has surprised to the downside, indicating a swift convergence of price changes toward the Federal Reserve’s 2% target. The headline consumer price index (CPI) peaked at 9.1% in June 2022 and has since moderated to the latest figure of 3%.
Market participants overwhelmingly expect that the Federal Reserve has concluded its hiking cycle, and rate cuts are anticipated to begin in Q1 2024, continuing throughout the year. However, Federal Reserve Chairman Jerome Powell has taken a more cautious approach, suggesting that future decisions should depend on data.
Despite rapid progress in cooling down inflation in recent months, the report believes that the Federal Reserve is likely to adopt a hawkish stance amid uncertainty, potentially hiking rates further this year. The report highlights three main reasons supporting this position.
Firstly, the US economy remains significantly overheated, leaving little room for complacency. Capacity utilization, taking into account the state of the labor market and industrial slack, indicates the presence of capacity constraints. This means there is currently higher labor demand than available employees, while industrial activity is above its long-term trend. These conditions may result in rapid price increases if commodity prices rebound or domestic consumption accelerates. The Federal Reserve is unlikely to cut rates or pause for an extended period until the labor market eases further and industrial spare capacity increases, providing the economy with a buffer to absorb shocks without risking rapid inflation spikes.
Secondly, tailwinds from commodity prices for inflation control are expected to reverse in the coming months. After a 22% decline from their peak in May 2022, commodity prices are stabilizing and are likely to recover further, especially as inventories draw down, and the global manufacturing cycle bottoms. Moreover, potential escalation of the Russo-Ukrainian conflict could create further upside risks for commodity prices, including energy and grains, leading to additional capacity constraints and fueling inflation acceleration.
Thirdly, the US economy has proven more resilient than previously expected, and further positive growth surprises would set a floor for inflation. Real GDP increased by 2.4% in Q2, well above most estimates of trend growth. The Federal Reserve’s high-frequency activity index has also significantly increased in recent weeks, suggesting strong growth momentum heading into Q3. This underlying strength is likely to add more pressure for the Federal Reserve to lean hawkish, given its need to maintain a 2% inflation target.
In conclusion, despite the aggressive rounds of rate hikes so far and substantial gains in moderating inflation, it is too early to claim victory over high inflation and the end of the tightening cycle. Capacity constraints, commodity headwinds, and a re-accelerating US economy may contribute to reversing the inflation trajectory over the short- or medium-term.
Source: Qatar News Agency