Banks raise Fed terminal rate forecasts after Powell’s hawkish tone

Banks raise Fed terminal rate forecasts after Powell’s hawkish tone

Investors and strategists are ramping up expectations for how much the Federal Reserve will raise interest rates in its effort to bring down inflation in the wake of Wednesday’s hawkish comments by Fed Chair Jerome Powell.

Futures traders since late on Wednesday have slightly lifted expectations for the Fed’s so-called terminal rate – the peak benchmark overnight interest rate in a policy tightening cycle – to 5.14% in June 2023.

Fed funds futures were pointing to a 5.02% terminal rate around May before the U.S. central bank’s Federal Open Market Committee on Wednesday announced it had raised its benchmark overnight interest rate by three-quarters of a percentage point, as expected. That pushed its fed funds target range to 3.75%-4.00%. The Fed also signaled that future increases in borrowing costs could be made in smaller steps.

That terminal rate forecast came down to 4.96% after the release of the Fed’s policy statement. But Powell’s comments in a news conference after the announcement rattled markets, which initially saw the policy statement as slightly dovish, and caused an upward adjustment in what the terminal rate is expected to be. Powell told reporters “it is very premature to be thinking about pausing” in the effort to lift the federal funds target rate.

Among the latest forecasts from firms, TD Securities raised its terminal rate forecast from a 4.75%-5.00% range to 5.25%-5.50%, and said it expects the Fed to raise rates by 50 basis points at its Dec. 13-14 policy meeting, according to a research note.

“The statement and press conference paved the way for a downshift in the future pace of hiking, but also made it clear that the Fed has a ways to go to tighten policy and will likely end up with a higher terminal rate than suggested” in September, TD Securities strategists wrote.

Economists at Nomura, meanwhile, raised their terminal rate forecast by 25 basis points to 5.50%-5.75%. They expect a 50-basis-point hike in December.

Strategists at BNP Paribas said they expect another 75-basis-point hike next month given that inflation should stay hot through the end of this year, while they think a policy “downshift” may be coming between December and February.

“We have greater confidence in our expectations for a higher terminal fed funds level, with fed funds reaching 5.25% by Q1 of next year and holding that level through 2023,” they wrote.

At Barclays, strategists said in a note that Powell “signalled a higher terminal rate” in his comments on Wednesday.

“We now expect a somewhat more drawn-out hiking cycle, but with the same peak rate,” they wrote. Their target range for the policy rate is at 5.00%-5.25% “at its peak.”

BofA strategists also expect a 50-basis-point hike in December, while they see the terminal rate in the 4.75%-5.00% range early next year, according to a research note.

The outlook could change if “labor markets retain significant momentum and curtailing that momentum may require tighter monetary policy than we currently anticipate,” they wrote.