The Fed has spoken – rate hikes will continue but the rate of increase will slow. This comes in the backdrop of inflation abating (which is still high by the way) and increasing risks to the functioning of the Treasury markets.
At the same time, the yield curve is getting more and more inverted. A yield curve inversion is a fairly reliable indicator of an impending recession anywhere from 6 to 18 months after it appears. The first sustained inversion happens in July this year. So that means there is a good chance we will see one next year.
And the Fed Funds futures market seems to be pricing that in. As of 30 November 2022, the market expects a 50bps increase in the Fed Funds rate to 4.5% at the next FOMC in December 2022. Thereafter, we are may see another 25-50bps increase in Feb 2023. By mid-year, there is a 50-50 chance of seeing the Fed Funds rate hit 5.25%. And what happens next is that the market expects the Fed to reverse and start cutting the rates by as much as 25-50 bps over the second half of 2023.
If a recession happens then and inflation comes down further, that will give Fed the room to lower the rates. But all these can change with new market developments. The key is inflation. In the months ahead, that will be one of they key deciding factor on whether the party continues or ends.
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