Wall Street appears to be finally embracing the idea that the Federal Reserve will raise interest rates into cap territory and stay at that high rate for a significant period of time. That is, the Fed will increase and hold, not increase and decrease as many in the markets predicted.
CNBC’s September Fed survey shows the median respondent believes the Fed will raise 0.75 percentage points, or 75 basis points, at Wednesday’s meeting, bringing the federal funds rate to 3.1%. The central bank is forecast to continue raising interest rates to a peak in March 2023 at 4.26%.
The new peak rate forecast represents a 43 basis point increase from the July survey.
Fed funds expectations
CNBC
On average, respondents predicted the Fed would remain at that peak rate for nearly 11 months, reflecting a range of views from those who said the Fed would hold its peak rate for just three months to those who said it would stayed there for up to two years.
“The Fed finally recognized the severity of the inflation problem and turned to sending positive real interest rate messages for an extended period of time,” wrote John Riding, chief economic adviser at Brean Capital, in response to the survey.
Riding sees a potential need for the Fed to hike to 5% from the current range of 2.25%-2.5%.
US Federal Reserve Chairman Jerome Powell gives a press briefing following the surprise announcement that the FED will cut interest rates on March 3, 2020 in Washington, DC.
Eric Baradat | AFP | Getty Images
At the same time, there was growing concern among the 35 respondents, including economists, fund managers and strategists, that the Fed would overtighten and trigger a recession.
“I’m afraid they’re about to overdo the aggressiveness of their tightening, both in terms of the size of the increases along with (quantitative tightening) and the speed at which they’re doing it,” Peter Bookwar, ch. chief investment officer at Bleakley Financial Group, wrote in response to the survey.
Boockvar was among those who urged the Fed to change and tighten policy too soon, a delay that many say has created the need for officials to act quickly now.
Those polled put the likelihood of a US recession in the next 12 months at 52%, little changed from the July survey. This compares with a 72% probability for Europe.
In the US, 57% think the Federal Reserve will tighten too much and cause a recession, while only 26% say it will tighten enough and cause only a moderate slowdown, down 5 points from July.
Jim Paulson, chief investment strategist at The Leuthold Group, is among the optimistic few.
He says the Fed “has a real chance of a soft landing” because the lagged effects of its tightening will so far reduce inflation. But that’s provided it doesn’t climb too far.
“All the Fed needs to do to enjoy a soft landing is to back off after raising rates to 3.25%, let real GDP growth remain positive and take all the credit as inflation declines while real growth continues,” Paulsen wrote.
The bigger problem, however, is that most respondents do not see the Fed being able to achieve its 2% inflation target for several years.
Respondents forecast that the consumer price index will end the year at 6.8% on an annual basis, down from the current level of 8.3%, and will further decline to 3.6% in 2023.
It won’t be until 2024 that the majority predicts the Fed will achieve its goal.
Elsewhere in the survey, more than 80 percent of respondents said they had not changed their inflation forecasts for this year or next year as a result of the Deflation Act.
Meanwhile, stocks appear to be in a very difficult position.
Respondents lowered their average 2022 outlook for the S&P 500 for the sixth straight survey. They now see the large-cap index ending the year at 3,953, or about 1.4% above Monday’s close. The index is expected to rise to 4,310 by the end of 2023.
At the same time, most believe the markets are more reasonably priced than they have been for most of the Covid pandemic.
About half say stock prices are too high relative to the outlook for earnings and the economy, and half say they are too low or about right.
During the pandemic, at least 70% of respondents said stock prices were too high in almost every survey.
CNBC’s risk/reward ratio — which measures the probability of a 10% upside minus a downside correction over the next six months — is closer to the neutral zone at -5. It was -9 to -14 for most of the past year.
The US economy is expected to stagnate this year and next, with growth forecast at just 0.5% in 2022 and little improvement expected in 2023, where average GDP is forecast at just 1.1%.
This means that at least two years of below-trend growth is the most likely scenario.
Mark Zandi, chief economist at Moody’s Analytics, wrote: “There are many potential scenarios for the economic outlook, but under any scenario the economy will struggle over the next 12-18 months.”
The unemployment rate, now at 3.7, is expected to rise to 4.4% next year. While still low by historical standards, it is rare for the unemployment rate to rise 1 percentage point outside of a recession. Most economists said the US is not in recession now.