S&P Global’s chief economist expects Fed’s fund rate to rise to 4%

The global rating agency S&P Global expects the United States Federal Reserve policy rate or the fed fund rate to rise to as high as 4 per cent as it fights a policy battle to bring down inflation in the world’s biggest economy. The US central bank has already raised its policy rate four times this year for a total of 225 basis points. One basis point is one-hundredth of a per cent.

“The core consumer inflation remains persistently high in the United States and the emerging consensus among economists is that Fed may have to raise its policy rate to 4 per cent to bring down inflation to its target zone,” said Paul F Gruenwald, global chief economist & managing director S&P Global. Mr Guenwald was speaking at an editor’s lunch in Mumbai.

The overall consumer inflation in the United States increased 0.1 per cent to 8.3 per cent in the month of August while the index for all items excluding food and energy also called core inflation was up 0.6 percent in August to 6.3 percent. In comparison, the Federal Reserve has a mandate to keep core inflation in a range of 0-2 per cent.

The global rating agency expects another 75 basis points rate interest rate hike by the Federal Reserve later this week which will take the US Fed Fund rate to 3.08 per cent from 2.33 per cent currently. If it comes through this will be the highest Fed Fund rate since January 2008.

“75 basis points is the new 25 basis points for central banks and markets will not be surprised at all if the hike comes through,” said Mr Gruenwald.

The current market consensus is that the terminal or neutral Fed fund rate would be in the range of 3 per cent to 3.25 per cent.

The Federal Reserve’s last forecast, in June, estimated the terminal rate for fed funds to be at 3.8 per cent in 2023.

A rise in the Fed fund rate to 4 per cent is expected to put upward pressure on bond yields across major economies including India. The yield on the benchmark 10-year treasury bond in India has cooled down in the last three months after reaching a 3-year high of 6.6 per cent in June this year to 7.26 per cent.

In the United States however bond yields are once again rising reversing the trend of decline in late June and July this year. The yield on 10-year US government bonds is up 89 basis points since the end of July while the yield on 2-year US government bonds is up 108 basis points during the period.

S&P Global says that this will translate into higher interest rates across the globe. “Interest rate policies of each central bank are driven by domestic factors but they can’t ignore monetary development in the US. Higher interest rates in the US will ultimately filter down into emerging markets like India,” said Mr Gruenwald.

According to him, the rate hike in the United States raised the probability of an economic recession in the world’s biggest economy over the next six months. Simultaneously he expects a growth slowdown in the European Union and China.

This will adversely affect economic growth in the world’s major emerging market economies. He however expects economic growth in India to be on the higher side compared to its emerging market peers despite a negative shock from global slowdown.