Fed interest rate at terminal level in current hiking cycle: Expert

ISTANBUL

The US Federal Reserve's interest rate reached its terminal level in its fight against inflation and the central bank is not expected to make any more rate hikes, according to an expert.

The terminal rate, the peak spot where the bank's federal funds rate is expected to climb before being trimmed, now stands at between the 5.25% - 5.5% target range, after the Fed skipped an interest rate increase for the third time at the conclusion of a two-day meeting Wednesday.

"We predict that the federal funds rate has reached its terminal level for the current hiking cycle," Martin Wurm, a director at Moody’s Analytics, told Anadolu via email.

"In his post-meeting press conference, Chairman Jerome Powell noted that while inflation remains too high, demand and supply conditions are coming more into balance. Importantly, labor markets showed lower trend payroll hiring and stronger prime age labor force participation in recent months," he said.

After soaring to 9.1% in June last year, its highest in more than 40 years, annual US consumer inflation dropped to 3% this June but climbed to 3.7% in September.

The US economy added 150,000 jobs in October, much lower than estimates of 180,000, according to the Labor Department figures released Friday.

"The Fed’s tightening also has dampened housing market activity and business investment, and the recent sell-off in the US Treasury market has caused credit conditions to tighten even further," said Wurm.

While the 30-year fixed mortgage rate rose to 7.9% last month, the highest since 2000, rates have been above 7% since early August 2023, according to the National Association of Realtors (NAR).

The 10-year US Treasury yield, in addition, climbed above 4.9% on Oct. 18 for the first time in more than 16 years.

Wurm, however, noted that Powell has left the door open for additional rate hikes.

"But in our estimation monetary policy is now sufficiently tight to bring inflation back to the Fed’s 2% target by late 2024. We agree with the chairman that the underlying resilience of the US economy makes a soft landing the most likely outcome," he said.

A soft landing is a situation where a central bank raises interest rates too much and too high, leading to an economic slowdown but avoiding a recession.

While many economists believed the Fed's unprecedented monetary tightening could push the US into a recession, the American economy expanded 4.9% in the third quarter, strongly beating market estimates of 4.3%, according to the Commerce Department's first and advance reading released last week.

What future awaits?

Wurm said he predicts the Fed will begin cutting interest rates by next June, and then lower them at every other meeting until 2026, by 25 basis points on average.

"By our estimates the Fed funds rate will then remain between 2.75%-3.0% until the end of the decade. This reflects our view that the neutral rate, that is the policy rate at which monetary policy is neither stimulates nor dampens economic activity, has risen to pre-global financial crisis levels," he said.

Wurm noted that the assumption is based on price shifts in Treasury and futures markets since the summer, as well as the US economy's stronger-than-expected performance despite the Fed’s aggressive tightening.

The American economy expanded 2.1% in the second quarter and grew 2% in the first, according to the Commerce Department's figures.

Interest rates, however, would come down quicker "should economic headwinds become bigger problems, for instance, if a resurgence in oil prices weighed more heavily on economic activity, or if higher rates reignited problems in the financial system," according to Wurm.

But "recession risks are still elevated, and we assume that the Fed would cut rates should the economy slow down more than expected," he said.