The Fed will raise interest rates again. But he is playing with fire

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The Federal Reserve is guaranteed to announce another rate hike on Wednesday. But investors hope it will be a smaller increase than the last four increases.

Traders only bet on a half-point increase. Federal funds futures on the Chicago Mercantile Exchange show an 80% chance of a half-point increase.

The Fed has raised interest rates by three quarters of a percentage point in its last four meetings (June, July, September and November). This follows two small rate hikes earlier this year. The central bank’s key short-term interest rate, which was near zero at the start of the year, is now in the 3.75% to 4% range.

The hope is that inflationary pressures are finally starting to subside enough that the Fed can turn the economy around to avoid a recession – talk about a series of smaller rate hikes from the Fed -.

But it may not be that simple. The government said on Friday that the Producer Price Index, a key measure of wholesale prices, rose 7.4% in the 12 months to November. That was slightly higher than the 7.2% rate expected, but a marked slowdown from the 8% growth through October.

The more closely watched Consumer Price Index data for November is released on Tuesday, a day before the Fed’s announcement. Through October, the CPI rose 7.7% year-on-year.

As long as inflation remains a problem, the Fed will have to tread carefully.

“Inflation has probably peaked, but it may not be coming down as quickly as people would like,” said Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research.

Jones still thinks the Fed will raise rates by just half a point this week, and may try to raise them by just a quarter point in early 2023. But he acknowledged that the Fed is now kind of “making it up as it goes along.”

Another problem: The Fed’s rate hikes this year have had limited impact on the economy so far. Yes, mortgage rates have risen, which has hit housing demand hard, but the job market remains strong. Wages are rising and consumers are still spending. This cannot go on forever.

“The cumulative effect of higher rates is just beginning. Therefore, the Fed should slow down a bit,” Jones said.

So investors will only have to pay attention to what the Fed says about rates in its policy statement and Powell’s press conference. The Fed will also release its latest forecasts for gross domestic product growth, the job market and consumer prices on Wednesday.

In September, the Fed’s consensus forecasts called for GDP growth of 1.2% in 2023, the unemployment rate at 4.4%, and personal consumption expenditures, the Fed’s preferred measure or inflation, of 2.8%. The Fed is likely to lower its GDP target and raise its expectations for the unemployment rate and consumer prices.

The likelihood of an economic recession is growing, and the Fed’s projections may reflect that. But the Fed is not expected to start cutting interest rates until 2024 at the earliest, so it may be too late for the central bank to avoid a recession.

“A pivot or a break is not a cure-all for this market,” said Keith Lerner, chief investment officer at Truist Advisory Services. “Interest rate cuts may be too late. Recession risks are still relatively high.

The US economy is not yet in recession. But are American buyers being harassed? We’ll know better this Thursday when the government reports retail sales figures for November.

Economists actually forecast a small 0.1% decline in retail sales from October. But it’s important to put this number in context. Retail sales rose 1.3% from September and 8.3% over the past 12 months.

So it’s possible for consumers to get just a head start on their holiday shopping. Inflation also has an effect on the numbers, as retail sales have been (positively) affected by the fact that people are spending more money on things.

A market strategist also noted that as price increases continue to slow, consumers will also feel more confident.

“Everyone is talking about inflation this year. The future will be more about disinflation in 2023 or 2024,” said Arnaud Cosserat, CEO of Comgest Global Investors.

What does this mean for investors? Cosserat said people should look for quality consumer companies that still have pricing power and can maintain profit margins. Two stocks his firm owns fit this bill: luxury goods maker Hermès ( HESAF ) and cosmetics giant L’Oreal ( LRLCF ).

Monday: UK monthly GDP; Earnings from Oracle (ORCL).

Tuesday: US Consumer Price Index; Germany’s economic mood

Wednesday: Fed meeting; EU industrial production; UK inflation; Earnings from Lennar (LEN) and (TCOM).

Thursday: US Retail; US weekly jobless claims; ECB and Bank of England rate decisions; Earnings from Jabil (JBL)

Friday: Eurozone PMI; UK retail; Earnings from Accenture (ACN), Darden Restaurants (DRI), and Winnebago (WGO).

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