[Tightening Era] Fed's Dot Plot Draws More Attention Than Rate Hike Size... The Key Is the 'Terminal Rate'

3 Consecutive Giant Step Likely

[Asia Economy New York=Special Correspondent Joselgina] At the two-day official meeting of the U.S. Federal Open Market Committee (FOMC), a third consecutive 'Giant Step' (0.75 percentage point interest rate hike) is virtually certain. The previously suggested 1 percentage point hike option seems to have lost momentum as it could potentially trigger market panic and increase recession risks.

Market attention is particularly focused more on the 'dot plot' than the size of the rate hike. This is because the terminal point of interest rate forecasts is rising due to persistently high inflation. Projections have started to exceed the 4% range, reaching up to 5%.

◇ Third Consecutive Giant Step Likely... How Far Will Rate Hikes Go?

If the Fed decides on a 0.75 percentage point rate hike at the FOMC meeting on the 20th-21st (local time), the U.S. benchmark interest rate will reach 3.0-3.25%. This would be the highest level since January 2008. According to the Chicago Mercantile Exchange (CME) Group's FedWatch, the federal funds (FF) futures market currently reflects an 84% probability of a Giant Step. Economic media CNBC also reported that respondents in a Fed survey released that day are leaning toward a 0.75 percentage point hike.

However, what is important in this meeting is not the immediate size of the hike but the dot plot showing FOMC members' interest rate path forecasts and the remarks of Fed Chair Jerome Powell. The dot plot released on the afternoon of the 21st and Powell's press conference will provide hints on how far future rate hikes will go and how long high interest rate levels will be maintained.

In the dot plot released in June, the Fed projected interest rates of 3.4% for this year and 3.8% for the end of next year. However, considering the August Consumer Price Index (CPI), which far exceeded expectations, an upward revision at this meeting is almost certain.

Experts voice that considering recent inflation trends, the Fed's terminal rate could rise to 4.25-4.5%. In the CNBC survey, the terminal rate was projected at 4.3% in March 2023, which is 0.4 percentage points higher than the survey before the July FOMC. The year-end rate was expected to be 3.9%. These results are analyzed as reflecting concerns over prolonged high inflation following recent CPI releases.

More hawkish voices have also emerged. Deutsche Bank expects the Fed's rate cycle to end only after reaching 4.9% in the first half of next year. Paul Ashworth, Chief Economist at Capital Economics, said, "There is still a possibility that the Fed will slow the pace of hikes," but also forecasted, "The terminal rate could be 4.5-5.0%, with risks of it going even higher."

◇ "1% Point Hike Possibility Underestimated" Also Pointed Out

Debates continue around the possibility of a 1 percentage point rate hike. Given the recent strong dollar and rapid rise in Treasury yields, the volatility caused by an ultra step hike could be even more shocking.

Sam Stovall, Chief Investment Strategist at CFRA, pointed out, "A 1 percentage point hike means the Fed is overreacting to data, which will make the market more anxious," and added, "Excessive tightening lowers the possibility of a soft landing." Michael Feroli, economist at JPMorgan Chase, also drew a line, saying, "A good driver does not speed up as the destination gets closer." This suggests that a 1 percentage point hike could signal panic to the market.

On the other hand, voices urging to keep the possibility of a surprise move open have also emerged. MarketWatch pointed out, "The market is underestimating the possibility of a surprise 1 percentage point hike," and added, "Due to recent inflation, the Fed might judge that stronger action is necessary." Nomura Bank had previously expected a 1 percentage point hike, and following Canada, the Swedish central bank also implemented a surprise 1 percentage point rate hike citing high inflation.

This content was produced with the assistance of AI translation services.