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27 Jan 2023

Econ Digest

First FOMC Meeting in 2023: Fed is expected to raise its policy rates by 0.25 percentage points after weakening inflation

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       At the first Federal Open Market Committee (FOMC) meeting of the year on January 31 - February 1, 2023, the U.S. Federal Reserve (Fed) is expected to raise its policy rates at a slower rate of 0.25 percentage points to 4.50-4.75%, as U.S. inflation continues to weaken. However, the focus remains on the extent to which the Fed will raise policy rates. The pace of the Fed’s future rate hikes will depend largely on U.S. economic data and inflation figures.

       U.S. headline inflation in December 2022 has declined for the sixth consecutive month, which is a good sign that inflation is starting to weaken. Therefore, the Fed is likely to raise its policy rates at a slower rate of 0.25 percentage points at the upcoming FOMC meeting, after an increase of 0.50 percentage points in the previous meeting. In December 2022, U.S. headline inflation fell for the sixth consecutive month to 6.5% YoY, the lowest level since October 2021, while U.S. core inflation, which excludes food and energy prices, also declined for a third straight month to 5.7% YoY.

       However, although inflation is weakening, it remains at a high level, while the U.S. labor market data continues to reflect strength. The number of first-time claims for unemployment benefits (week of January 8-14, 2023) has fallen to 190,000, which is much better than market expectations, so the Fed may continue to raise its policy rates. Amid signs of weakening inflation, the Fed will consider raising the policy rate at a slower rate of 0.25 percentage points at the upcoming FOMC meeting.

       Looking ahead, the pace of the Fed’s future rate hikes will depend largely on U.S. economic data and inflation figures released. K-Research believes that after the FOMC meeting in January 2023, if U.S. inflation continues to weaken and the U.S. economy slows, the Fed may raise its policy rates only one more time, resulting in the U.S. policy rates remaining at a peak of around 5.0%.

       The U.S. economy is beginning to show signs of slowing down, as reflected by a decline in U.S. retail sales for the second consecutive month in December 2022. The Manufacturing Purchasing Managers’ Index (preliminary data of January 2023) while up slightly from the previous month, remains below 50, indicating a contraction in the U.S. manufacturing sector. KResearch expects the U.S. economy in 2023, especially in the first half, to feel the impact of the Fed’s continuous rate hikes from last year. Overall, the U.S. economy is likely to have flat growth (zero GDP growth) this year, so the Fed may need to weigh economic risks more heavily going forward.

       Although U.S. inflation is still significantly above the Fed’s 2.0% target, the inflation is expected to gradually decline this year as commodity prices are likely to come under pressure from a global economic slowdown. While an optimistic outlook for China’s economy may have pushed commodity prices up slightly, prices are not expected to spike as much as they did at the start of the Russia-Ukraine war in 2022. Under the above assumptions, KResearch therefore believes that the Fed may raise its policy rates only one more time at its meeting in March 2023, bringing the U.S. policy rates to a peak of around 5.0%, and the Fed may keep the policy rate at this level throughout 2023. However, if U.S. inflation remains high and does not decrease as it should, and the labor market continues to strengthen, those factors would encourage the Fed to continue raising its policy rates above 5.0%.

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