Fed to hike 75bp later this month

We are changing our call for the 20-21 September FOMC meeting to a 75bp hike, from our previous expectation of a 50bp move. While the August employment report last Friday suggested some cooling in the labour market, a flurry of Fed officials in recent days have made hawkish comments suggesting little appetite to slow down the pace of rate hikes just yet. An article by the Wall Street Journal (usually a reliable source when it comes to Fed policy moves) also suggested a 75bp hike was the preferred option for September. We had previously preferred to wait for the August CPI inflation reading – due next Tuesday – to make a final call on the size of the September hike, but we now judge that even a weak inflation number for August would be unlikely to sway the Committee (especially as the inflation data comes out during the blackout period, leaving no room for the Fed to provide any signals to markets).

Projected peak in rates unchanged at 4%; now likely in December

While we expect a front-loading of rate hikes, we keep our expectation for the peak in fed funds rate at 3.75-4.00%, but now expect this to be reached in December (previously February). Assuming a 75bp hike in September, this implies a 50bp hike in November, followed by one last 25bp move in December. This would mean policy is firmly in restrictive territory by the end of the year – assuming a neutral rate of c.2.5% – and we expect rates to stay there for at least six months. We think it will take a substantial rise in unemployment (1-1.5pp), and several months of sustained month-on-month inflation readings consistent with 2% annual inflation, for the Fed to start cutting rate. Assuming our macro scenario of a mild recession pans out over the coming quarters, we continue to expect the Fed to start modestly cutting rates in the second half of 2023, taking the upper bound of the fed funds rate back down to 3% by end-2023.