US Federal Reserve Faces Critical Interest Rate Decision Amidst Inflation Concerns

Today, the US Federal Reserve is set to make a crucial decision regarding interest rates. Market expectations, despite recent negative surprises in US inflation data, suggest that the Fed will opt to maintain the current interest rate range of 5.25-5.5% until the year’s end. However, the likelihood of a rate cut is diminishing.

Is there a possibility of an interest rate hike today?

Last week, the US consumer price index revealed a higher-than-expected annual inflation rate of 3.7%. While the index indicated that core components were moderating, the core index still stands at over 4%, significantly exceeding the Fed’s inflation target of an average of 2%.

Surprisingly, despite these ongoing price increases, the probability of an interest rate hike by the Fed this Wednesday is almost negligible, as indicated by the CME website, which gauges the likelihood of such an event. Furthermore, following the release of the inflation data, the probability of an interest rate hike later this year has decreased.

Dodi Reznik, an interest rate strategist at Bank Leumi, believes that the market is now pricing in almost zero chance of an interest rate increase. He suggests, “The Fed typically avoids surprises in such situations, and I would be extremely surprised if they decide to raise interest rates.” According to a Goldman Sachs review from last week, the era of interest rate hikes by the Fed has likely concluded.

Are interest rate hikes truly over?

Federal Reserve officials consistently emphasize that data will guide their interest rate decisions at each meeting. Therefore, statements made by Fed Chairman Jerome Powell after the decision will hold significant weight regarding the bank’s continued hawkish stance or a shift toward a more dovish approach to monetary policy.

Uri Greenfeld, Chief Strategist at Psagot, notes that the Fed is beginning to see signs of inflationary factors easing: “The index produced a negative surprise, but the core index continues to slow down. The Fed recently stated that private consumers had exhausted their savings from the COVID-19 period, suggesting a slowdown in private sector consumption.” Greenfeld, who anticipates no further interest rate increases, posits that although core indices remain high, they are expected to continue declining in the future. “When the Fed makes a decision, it expects to see a change about a year later. Due to market time lags, the Fed perceives the affirmative, the moderation, and the upward trends.”

On the other hand, Reznik points out that US data increases the likelihood that the Fed will continue raising interest rates later this year: “The likelihood of another interest rate increase is not low. The Fed wishes to see continued inflation moderation and will adjust interest rates less frequently as circumstances warrant.” Reznik adds that if energy prices continue to rise, preventing inflation moderation, the probability of further interest rate hikes will increase.

David Benjaminov, a research analyst at Global X, estimates that “given the robust data in the US market, the Fed will likely opt to raise interest rates by a quarter percentage point at the next meeting in November.” Benjaminov believes that the market is underestimating the probability of further interest rate hikes, with a 35% chance of an increase in November. “We anticipate that Chairman Powell will express a hawkish stance at this week’s meeting,” he concludes.

Bank of America also anticipates that the Fed will need to raise interest rates once more before the end of the year. The bank’s report underscores central bank officials’ concerns about a potential resurgence of inflation, particularly in light of the strong economic activity in the US.

What about medium and long-term interest rates?

Although the conclusion of the interest rate hike cycle appears imminent, the Fed is likely to maintain high interest rates for an extended period as it continues to combat inflation. Forecasts indicate that interest rates will remain elevated, placing a burden on consumers for an extended duration. Reznik points out that these forecasts have steadily shifted throughout the year. “At the beginning of 2023, we expected interest rate decreases and monetary easing to commence towards the end of the year. Later, it appeared this might happen in early 2024. Now it seems interest rate cuts may not occur until the middle of next year or even later, around June or July.”

Goldman Sachs anticipates interest rate cuts will only commence in the second quarter of 2024. Furthermore, the forecasts of major banks suggest that even when the Fed begins to lower interest rates, it will maintain them at higher levels even as inflation moderates. Goldman predicts that interest rates, when they eventually decrease, will hover around 3%, while Bank of America notes that the expected median interest rate for 2024 has risen to 4.875% from previous forecasts. The bank underscores the increased risks associated with even higher predicted interest rates.

What does this mean for Israel?

In Israel, the latest price index indicates an uptick in inflation, with recent data surpassing economists’ expectations at 4.1%. However, there is still more than a month until the next interest rate meeting of the Bank of Israel’s monetary committee on October 23, leaving room for additional data to influence deliberations.