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Fed: FOMC may signal smaller increases after November

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The gradual approach to tightening in monetary policy may be eroded by cyclical changes. The “temporary inflation” approach was quite risky in the period when the inflation was the hottest, and from the “Burns school” (which could not control inflation in the 70s) to the Volcker approach (which was painful in the 70s) against the danger of inflation that was permanent, painful and reflected in lower income groups. Now, views are taking shape that this approach should evolve in the opposite direction again.

Today’s FOMC members support aggressive front-loading rate hikes, drawing lessons from the Burns-era failed disinflation campaign of the 1970s. The conditions that brought the Volcker approach, which supports the hard rate hike campaign and proactive front-loading approach, are similar to the conditions we are in. Inflation is in its fastest cycle since the 1980s, and the direction of the Fed’s proactive tightening in this area has always been raising nominal interest rates above inflation. In other words, after the Fed set the peak above inflation, it started to cut interest rates, the threshold of which is far ahead because inflation is at 6% on PCE basis and 8% on CPI basis. A 75 basis point increase at the November meeting brings the fed funds rate to the 3.75%-4% band, more than 2 points below the Fed’s favorite benchmark. A federal funds rate of 6% or 8%, in a position to settle for 4% inflation before stabilizing at 2%, points to a scale that is feared bringing the recession threshold closer.

What we have told so far is about the causes and consequences of the proactive approach. The hard landing risk we talked about in the last sentence also reiterates the call for caution and a gradual approach. The detail that this lacks is the possibility of repeating the unsuccessful prediction that inflation is temporary in 2021. The issue of how it will feed the inflation phenomenon given some important issues is important. Such as retail sales showing the demand situation, durable goods orders or wage inflation with both demand and cost effects… When the FOMC meets again in December, it will revise its projections and dot plot made in September, and the strength of these arguments will be decisive in the forecast about the peak interest rate.

In summary; The Fed is expected to raise interest rates by 75 basis points at its fourth meeting in a row. The solid core inflation readings currently seen justify such jumbo-size rate hikes. Less certain is whether the Fed will downshift in December and beyond. Powell’s statements on this subject are important both in terms of the possible risks of the interest rate increase and whether a possible slowdown of the Fed will mean a lower terminal interest rate. Powell could possibly prepare the market for a 50 basis point hike in December. However, the risks that shape the perception about inflation are two-sided, falling commodity prices may create optimism and shift the perception to 25 basis points, solid core inflation readings and the recent rise in gasoline prices may provide a shift to the possibility of 75 basis points.

When we look at what could cause the 75 basis point increase for the fifth time in a row, we are faced with uncertainties about gasoline prices and how this will result when the ceiling price applied to Russian oil comes into effect this year. In the event of a regression towards an increase of 25 basis points, both the disinflation in goods prices and the cooling in the labor market may lead us towards a slower cycle than currently expected. Therefore, a cautious stance will be taken regarding Fed pivot expectations, stopping rate hikes or switching to rate cuts. This will be perceived as a hawkish explanation, unless the slowdown in the rate of interest rate increases does not mean that the terminal rate will fall.

Kaynak: Tera Yatırım-Enver Erkan

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