US Fed Could Hike Rates Above 4% By Year End: MIDF

The US Fed’s FOMC decided to hike the Fed funds rate to 3.00–3.25%, the third back-to-back 75bps increase since Jun-22. The decision was broadly in line with market expectations in reaction to the inflation remaining at a high level in Aug-22 and still strong labour market condition.

In addition to the rate hike, the Fed will proceed with its plan to reduce its balance sheet, where the amount of reduction will be doubled to USD95b per month starting from this month. As of mid-September 2022, Fed already trimmed down its balance sheet to USD8.833 trillion, a total reduction of USD132.7b from the highest level in mid-April 2022. Consequently, following the monetary policy tightening, real money as measured by M2 declined by -3%yoy in Aug-22, registering an annual fall for the fourth month in a row.

The strong labour market, high wage growth, and rising personal consumption support further rate hikes by the Fed. Taking into account the elevated inflation and the strength in the US economy, MIDF expects further rate hikes by the Fed which will push the fed funds rate above 4% (compared to 3% previously) by end of this year.

Reading from the message from the Fed Chair, the Fed will prioritise tackling high inflation even if it costs the US economy to slow sharply. In other words, the Fed wants to see significant changes now to bring down inflation in the longer run. As we head towards year-end, further easing of US inflation will likely result in smaller rate hikes (either 25bps or 50bps). The lag effect of monetary policy changes on the real economy suggests the US economy could slow going into next year, and softer demand will help to bring down inflation, apart from improving supply. But, if inflation remains stickily high and not easing as
fast as projected, the Fed may be forced to raise Fed funds rate to even higher levels.

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