US Weekly Economic Commentary: Fed will downshift to “50”

The better-than-expected Consumer Price Index report for October supports a downshift in the pace of Fed rate hikes in December.

Even before that report, the Federal Reserve was poised to slow from super-sized increases of 75 basis points at each of the last four policy meetings to a still large increase of 50 basis points at the upcoming policy meeting on Dec. 14.

A downshift is consistent with recent Fed communication, including the Federal Open Market Committee statement issued on Nov. 2, Chair Powell's press conference on the same date, and comments from individual policymakers. Those communications highlight the need to adhere to a data-dependent, meeting-by-meeting approach that would allow more opportunity to assess the cumulative impacts of Fed rate hikes and lower the risk of over-tightening policy.

To that point, the report on the CPI contained hints — and we stress only hints — that inflation may be easing, although it still is very high. On a 12-month basis, overall CPI inflation was 7.7% in October and core CPI inflation was 6.3%. Based on details in the CPI that inform the Fed's preferred inflation gauges within personal consumption expenditures (PCE), we estimate that the core PCE price index rose 0.3% in October, which would be the smallest increase in 3 months, while its 12-month change eased slightly to 5.0%.

This is still far above the Fed's 2% target, and it will keep the Fed on course to continue to tighten into a substantially restrictive stance. Nevertheless, the modest easing in inflation that occurred in October will reinforce the argument that it is appropriate to moderate the pace of rate hikes. We expect a Fed rate hike of 50 basis points in December, followed by a pair of quarter-point rate hikes in February and March. These increases would bring the target for the federal funds rate to a peak range of 4¾% to 5%, where we expect it to remain for some time until inflation falls close to 2% on a sustained basis.

Recession expectations

We expect the US economy will weaken and tip into a modest recession around the end of this year. We expect a cumulative decline in GDP through the second quarter of next year of just 0.7%, which would be one of the mildest recessions in recent decades. The tightening of financial conditions since last year has already pushed spending on home construction into recession and has undermined strength in other areas of private demand, including nonresidential structures investment and PCE.

We expect GDP to post a modest annualized decline in the fourth quarter of ‑0.3% — although volatile data on inventories and net exports could result in a higher or lower figure. By year, we expect GDP to be flat (0.0%) on a four-quarter change basis in both 2022 and 2023, followed by an increase of 1.6% in 2024. Labor demand will soften and push the unemployment rate up to 5.7% next year.

This week's economic releases:

• Producer price index for final demand (Nov. 15): We estimate a 0.4% increase for October, equal to the increase in September. For core PPI, which excludes the direct effects of changes in prices for food and energy, we estimate a 0.3% increase for October.
• Retail and food service sales (Nov. 16): We estimate a 0.8% increase for October, compared with no change in September.
• Industrial production (Nov. 16).
• New residential construction (Nov. 17): We estimate housing starts fell to 1,401 thousand units in October from 1,439 thousand units in September. We estimate housing permits dipped to 1,534 thousand units in October from 1,564 thousand units in September. This would continue what has been a declining trend in housing starts, as multifamily housing starts have been resilient and single-family housing starts have weakened under the weight of sinking affordability.
• Existing home sales (Nov. 18): We estimate existing home sales declined to 4,434 thousand units in October from 4,710 thousand units in September. A decline was foreshadowed by a whopping, 10.2% decline in NAR's Pending Home Sales Index (PHSI) in September — the PHSI measures sales contracts, while existing home sales measures closings, which typically follow contracts by four to six weeks.
• Conference Board's Leading Economic Index (Nov. 18): A decline would continue a trend in the index since last spring and would be consistent with our view that the US economy is about to tip into a mild recession.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.