US Federal Reserve Chairman Jerome Powell gives a press briefing following the surprise announcement that the FED will cut interest rates on March 3, 2020 in Washington, DC.
Eric Baradat | AFP | Getty Images
Wall Street finally seems to be embracing the idea that the Federal Reserve will raise rates into restrictive territory and stay at that high rate for a substantial period of time. That is, the Fed will rise and hold, not rise and fall as many in the markets had expected.
CNBC’s September Fed survey shows the average respondent thinks the Fed will hike 0.75 percentage points, or 75 basis points, at Wednesday’s meeting, taking the fed funds rate to 3.1 %. The central bank is expected to continue to rise until the rate peaks in March 2023 at 4.26%.
The new peak rate forecast represents an increase of nearly 40 basis points from the July survey.
Federal Funds Expectations
Respondents on average expect the Fed to stay at this maximum rate for nearly 11 months, reflecting a range of views from those who say the Fed will hold its maximum rate for as little as three months to those who say he will maintain it for up to two years.
“The Fed has finally realized the seriousness of the inflation problem and has moved toward a positive real policy rate for an extended period,” wrote John Ryding, chief economic adviser at Brean Capital, in response to the survey. .
Ryding sees a potential need for the Fed to hike up to 5%, from the current range of 2.25% to 2.5%.
At the same time, concern is growing among the 35 respondents, including economists, fund managers and strategists, that the Fed will overdo its tightening and cause a recession.
“I fear they are about to overdo it with the aggressiveness of their tightening, both in terms of the size of the hikes and (quantitative tightening) and the speed at which they are doing it,” Peter Boockvar , chief investment officer of Bleakley Financial Group, wrote in response to the survey.
Boockvar was among those who urged the Fed to pivot and tighten policy early on, a delay that many believe created the need for officials to act quickly now.
Respondents put the likelihood of a recession in the United States over the next 12 months at 52%, little change from the July survey. This compares to a 72% probability for Europe.
In the United States, 57% believe the Fed will tighten too much and cause a recession, while only 26% say it will tighten just enough and cause only a modest slowdown, down five points from July.
Jim Paulsen, chief investment strategist at The Leuthold Group, is among the few optimists.
He says the Fed “has a real chance of achieving a soft landing” as the lagged effects of its tightening to date will reduce inflation. But that’s on condition that he doesn’t walk too far.
“All the Fed needs to do to enjoy a soft landing is pull back after raising the funds rate to 3.25%, allow real GDP growth to stay positive, and take all the credit as inflation declines while real growth persists,” Paulsen wrote.
The bigger problem, however, is that most respondents don’t see the Fed succeeding in hitting its 2% inflation target for several years.
Respondents expect the Consumer Price Index to end the year at a 6.8% year-over-year rate, down from the current level of 8.3%and fall further to 3.6% in 2023.
It’s not until 2024 that a majority expects the Fed to achieve its goal.
Elsewhere in the survey, more than 80% of respondents said they had made no changes to their inflation forecasts for this year or next due to the Inflation Reduction Act.
In the meantime, stocks appear to be in a very difficult situation.
Respondents cut their average outlook for 2022 for the S&P 500 for the sixth consecutive survey. They now see the large cap index ending the year at 3,953, about 1.4% above Monday’s close. The index is expected to reach 4,310 by the end of 2023.
At the same time, most believe market prices are more reasonable than they were for most of the pandemic.
About half say stock prices are too high relative to the outlook for earnings and the economy, and half say they are too low or about right.
During the pandemic, at least 70% of respondents said stock prices were too high in nearly every survey.
CNBC’s risk-reward ratio — which measures the likelihood of a 10% upside correction minus downside over the next six months — is closer to the neutral zone at -5. It has been -9 to -14 for most of the past year.
The US economy is expected to slow this year and next with only 0.5% growth forecast in 2022 and little improvement forecast for 2023, where the average GDP forecast is just 1.1%.
This means that at least two years of below-trend growth is now the most likely case.
Mark Zandi, chief economist at Moody’s Analytics, wrote: “There are many potential scenarios for the economic outlook, but regardless of the scenario, the economy will struggle over the next 12 to 18 months.”
The unemployment rate, now at 3.7, is expected to reach 4.4% next year. Although still low by historical standards, it is rare for the unemployment rate to increase by 1 percentage point outside of a recession. Most economists have said that the United States is not currently in a recession.