Fed May Surprise with More Rate Cuts in 2023
The Federal Reserve could deliver more interest rate cuts than markets anticipate this year, according to State Street. Factors supporting a more accommodative monetary policy in 2023 include:
1. Slowing Economic Growth
GDP growth is projected to moderate in 2023, putting downward pressure on US Treasury yields. This will provide the Fed with more room to cut rates.
2. Resuming Disinflation
Inflation is expected to ease in 2023, allowing the Fed to reduce rates further.
3. Improved Fiscal Health
Stronger tax revenues and slowing entitlement spending will improve the government's financial health, reducing pressure on bond yields and providing additional room for rate cuts.
Michael Arone, chief investment strategist at State Street, predicts the Fed will cut rates more than the single 25-basis point reduction currently priced in by markets. He suggests the Fed could cut rates three times by a total of 75 basis points in 2023.
This flexibility stems from the Fed's target rate remaining significantly above its preferred inflation measure. The central bank aims for a real policy rate of approximately 100 basis points above inflation, providing ample room for further rate cuts.