What instruments to use to face persistent inflation?

“With a continuous process of inflation, governments can secretly and inadvertently confiscate a significant part of the wealth of their fellow citizens.” ―John Maynard Keynes

The Federal Reserve’s Open Market Committee seeks to obtain maximum employment by reducing inflation to 2% in the long term. To achieve that goal, the Committee decided to raise the target range for the Federal Funds rate from 4.25 to 4.5 percent.

The Committee anticipated that the increases in the inflation target range would be appropriate to return inflation to 2% in the short term. To determine the rate of future increases in the target range, the Committee must take into account the accumulated tightening of monetary policy, the lags with which monetary policy acts on economic activity and inflation, and economic and financial developments. .

With the end of the year drawing near, business activity is likely to remain subdued and that could dampen the market’s reaction to the results and Fed specialists over the next couple of weeks.

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Markets appeared unconvinced by the Fed’s hawkish outlook following Wednesday afternoon’s rate hike, as traders viewed the Fed’s future path as particularly uncertain and data-dependent, which would require releases to be further analyzed in the future.

In addition to raising rates by 50 basis points, in line with expectations, the FOMC’s Summary of Economic Projections also reflected an increase in expectations for future rate increases, raising the expected year-end rate to 5.1% from 4.6 percent.

Fed Chairman Jerome Powell noted that “FOMC participants overwhelmingly believe inflation risks are on the upside,” calling the labor market “very, very strong.”

The FOMC also lowered its 2023 GDP outlook to 0.5% from 1.2%, and raised the 2023 unemployment rate to 4.6% from 4.4%, but still raised its inflation forecast to 3.5% from 3.1%.

This was largely due to the higher starting point considered for 2023 relative to September expectations, but it still meant that the Fed expects inflation to remain high enough to raise rate hike expectations, as that Committee members require evidence of declining inflation before trusting that it is on its way to 2 percent.

Markets are fully pricing in a 25 bp rate hike for the February meeting, with just over 25% chance of a 50 basis point hike.

We believe the Fed will increase the target range for the federal funds rate by 25 basis points in February to 4.75%, and then pause for the remainder of 2023.

It is unlikely that any major changes will be made to the monetary policy forecasts, as inflation results are expected to be seen first and at their February meeting.

Even if this were done, the changes to the forecasts for economic growth and inflation would be very slight. An additional 50 basis points of monetary policy tightening by the Fed would reduce GDP growth by 0.1 to 0.2 percentage points over the course of a year and raise the unemployment rate slightly.