Fed will make two 25 basis point hikes in Q1, followed by a long pause

BENGALURU, Jan. 20 (Reuters) – The US Federal Reserve will end its tightening cycle after raising 25 basis points at each of its next two policy meetings and then likely keep interest rates stable for at least the rest of the year, according to most economists in a Reuters poll.

Fed officials are broadly in agreement that the US central bank needs to slow the pace of tightening to assess the impact of rate hikes. The Fed raised overnight rates by 425 basis points last year, with most of the tightening taking place in steps of 75 and 50 basis points.

As inflation continues to fall, more than 80% of forecasters in Reuters’ latest poll, 68 out of 83, predicted the Fed would shift back to a 25 basis point hike at its Jan. 31-Feb. 1 meeting. If realized, that would push the key rate – the federal funds rate – into the range of 4.50% – 4.75%.

The remaining 15 expect a 50 basis point increase in two weeks, but only one was from a US primary dealer bank that deals directly with the Fed.

Fed Funds rates were expected to peak at 4.75%-5.00% in March, according to 61 out of 90 economists. That was in line with interest rate futures pricing, but was 25 basis points lower than the median point for 2023 in the dot plot projections released by Fed policymakers at the end of the December 13-14 meeting.

“Inflation in the US shows that price pressures are easing, but in an environment of a strong job market, the Federal Reserve will be wary of naming interest rates at the top,” said James Knightley, chief international economist at ING.

Expected final interest rates would be more than double the peak of the last tightening cycle and the highest since mid-2007, just before the global financial crisis. There was no clear consensus on where the Fed’s policy rate would be at the end of 2023, but about two-thirds of respondents had a forecast of 4.75%-5.00% or higher.

Survey interest rates fell slightly behind recent Fed forecasts, but poll medians for growth, inflation and unemployment were broadly in line.

Inflation was predicted to fall further, but to remain above the Fed’s target of 2% for years to come, making rate cuts relatively unlikely in the near term.

In response to a supplementary question, more than 60% of respondents, 55 of 89, said the Fed would hold rates steady for at least the remainder of the year rather than lower them. That view was consistent with the median projection from the survey for the first cut in early 2024.

However, a significant minority, 34, said interest rate cuts were more likely than not this year, and 16 cited a nosedive in inflation as the main reason. Twelve said a deeper economic downturn and four said a sharp rise in unemployment.

“The Fed has prioritized inflation over employment, so only a sharp drop in core inflation can convince the FOMC (Federal Open Market Committee) to cut rates this year,” said Philip Marey, senior US strategist at Rabobank.

“While the inflation peak is behind us, the underlying trend continues…we don’t think inflation will approach 2% before the end of the year.”

Reuters Poll – US Federal Reserve Outlook

In the meantime, the Fed is more likely than not to help push the economy into a recession. The poll showed a nearly 60% chance of a U.S. recession within two years.

While that was lower than the previous poll, several respondents had not attributed recession probabilities to their forecasts, as a slump was now their base case, albeit a short and shallow one, as predicted in several previous Reuters surveys.

The world’s largest economy was expected to grow just 0.5% this year before recovering to 1.3% in 2024, still below the long-term average of about 2%.

With mass layoffs underway, especially at financial and technology companies, the unemployment rate was expected to rise to an average of 4.3% next year, from the current 3.5%, and then rise again to 4.8% next year.

While still historically low compared to previous recessions, forecasts were about 1 percentage point higher than a year ago.

(For other stories from Reuters’ global economic poll:)

Reporting by Prerana Bhat; Poll by Milounee Purohit; Edited by Ross Finley and Paul Simao

Our Standards: The Thomson Reuters Principles of Trust.

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