The Federal Reserve will hike rates by a half-percentage point this week but Fed Chairman Jerome Powell will be hawkish, opening the door to larger move at subsequent meetings, economists said.
The surprisingly strong May consumer inflation report was a game-changer for the Fed, ensuring that Powell will take a hawkish stance.
See: Rising rents, gas and food prices push U.S. inflation to 40-year high of 8.6%, CPI shows
“Doves don’t exist on the committee right now,” said Rob Dent, U.S. senior economist at Nomura, in an interview.
The consensus of economists was still that the Fed will raise its benchmark rate by a half-percentage point next week and again at its next meeting on July 28-29. But a 75-basis point hike will clearly be discussed.
Several economists think there is a chance of a more aggressive move this week.
Jonathan Millar, acting chief U.S. economist at Barclays Investment Bank, thinks the Fed will surprise the markets with a 75 basis point move on Wednesday.
“It does seem they need to do something bold here,” to reinforce their inflation-fighting credibility, Millar said in an interview.
At the moment, the Fed’s policy rate is in the range of 0.75% – 1%.
Fed officials will meet next Tuesday and Wednesday. The central bankers will release a policy statement and updated economic projections at 2 p.m. Eastern and Fed Chairman Jerome Powell will hold a press conference at 2:30 p.m. Eastern.
Michael Pearce, senior U.S. economist at Capital Economics, said Powell has no choice but to be hawkish.
“The only think that would stop them from being hawkish is if they were worried about the economy. And everything suggests the economy is pretty strong,” he said.
Pearce said it will interesting if Powell will give explicit forward guidance on a larger rate hike.
“They can’t signal any let up. They have to signal a willingness to do whatever it takes on the the hawkish side,” agreed Julia Coronado, president of MacroPolicy Perspectives.
The Fed is going to provide new estimates of how high its benchmark interest rate may go.
In March, the Fed penciled in a 1.9% rate at the end of the 2022 and a 2.8% rate for the end of 2023.
Dent said he thinks the Fed will pencil in a range of 2.75%-3% for the end of this year. And the Fed will signal the benchmark rate will rise to 3.1% in 2023 “at a minimum,” he added.
“The basic story we’re expecting is a steeper path and a higher terminal rate,” Dent said.
Talk is increasing that the Fed will have to raise its benchmark rate sharply higher.
Economists at Deutsche Bank think the Fed will eventually raise its benchmark rate to 4% to combat inflation.
Talk of a pause in September floated by Atlanta Fed President Raphael Bostic has been shelved.
In the wake of the consumer inflation data, economists think it will be harder for the Fed to get inflation under control without causing a recession.
In March, the Fed painted a picture of a “soft landing” where the Fed would hike its benchmark interest rate but the unemployment rate would stay low.
But because inflation is a “lagging indicator” demand is likely to slow first, said Coronado.
Choosing between economic growth and inflation is a choice the Fed didn’t want to make, but Dent of Nomura said it is not a “tough choice.”
“Price stability is everything the Fed has fought for over the past years. It is the bedrock of what they do,” Dent said.
Many economists say a recession in 2023 in unavoidable, according to survey of economists by the Financial Times.
Dent said he expects a narrow escape from a recession, with the economy only growing at a 0.6% rate over the four quarters in 2023.
“It is not a recession but it is very weak growth. It would not take much to tip the economy into recession at all,” Dent said.
Michelle Meyer, chief economist at Mastercard, said that spending data is still showing consumers spending money, even on travel and “experiences.”
“There are headwinds and a moderation in consumer spending over the rest of the year is very likely a reasonable thing. But by no means are we seeing signs of the consumer capitulating here at all,” Meyer said.
Pearce of Capital Economics agreed there were encouraging signs the economy could avoid a recession.
Job growth has slowed in the hospitality sector and wage growth has slowed. “And that’s what we’re aiming for,” he said.
All three major U.S. stock benchmarks
opened sharply lower on Monday. The yield on the 10-year Treasury note rose to 3.27%, the highest since May 2011.
See also: Dow slumps nearly 900 points as stocks end sharply lower, book big weekly losses after hotter-than-expected inflation in May