Meera Pandit:                  

Hi, my name is Meera Pandit, Global Market strategist at JP Morgan Asset Management. Welcome to On The Minds of Investors. Today's topic, when can the Feds stop hiking interest rates? During the September FOMC Press Conference Chair Powell noted that the committee would like to see positive real rates across the entire yield curve as one indication that they have reached an appropriate policy stance.

A real rate of interest is a nominal rate that investor or lender receives or expects to receive adjusted for inflation. Yet calculating real rates based on actual inflation like CPI or PCE or inflation expectations signals different levels of appropriate policy stance. The FOMC's latest economic projections show a terminal federal funds rate at 4.6% in 2023. That implies the Fed could hike 75 basis points in November, 50 basis points in December, and 25 basis points on February 1st to reach a target range of four and a half to 4.75%.

At that point, the Fed will have a December print for the PCE deflator and CPI. With core PCE already at 4.6% year over year through July and lower commodity prices weighing on headline inflation, it is plausible that the real federal funds rate will be positive at that point based on both measures of PCE allowing the Fed to take its foot off the gas. However, the Fed has never stopped hiking rates while the federal funds rate is below CPI. It would take monthly prints closer to one 10th of a percent month over month on core CPI and out rate monthly deflation on headline CPI to bring inflation below the federal funds rate by the February meeting.

Inflation is slowing but may not be slowing quickly enough, creating a potential timing issue for the Fed. Yet real rates are already positive across the curve today when looking at tips yields, which are essentially nominal yields minus inflation expectations highlighted in the chart below. By this measure, another 150 basis points of tightening could well go beyond what is necessary to bring down inflation and meaningfully raise the likelihood of recession.

Different measures of real rates signal different paths for Fed hikes. Not only does this risk a policy error, but also continues to generate uncertainty for investors trying to assess the end of the hiking cycle, which is contingent upon some combination of positive real rates, a softening labor market and disinflation. This is likely to prolong interest rate and equity volatility in the near term, warranting a cautious and diversified approach from investors.