Threat to America as top central banker promises to get the job done

US interest rates are rising at breakneck speed and, after last night’s hike, one expert reveals the maximum rate the US economy can withstand. They also name five themes to play the market right now.

Hopes of a soft landing for the US economy are fading after the Federal Reserve signalled the need for further aggressive rate rises on top of last night’s latest 0.75% increase.

The Fed funds rate jumped to 3-3.25%, but the central bank’s hawkish tone and chairman Jerome Powell’s determination to bring inflation back under control suggests rates could now peak at 4.5%-4.75% in early 2023.

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UBS Global Wealth Management warned this morning: “Our view is that a Fed funds rate of 4% is about the highest that the US economy would be able to withstand, and the Fed is clearly threatening to raise rates above that level.”

The Swiss bank’s chief investment officer Mark Haefele said he hoped that inflation may be low enough for policymakers to pause the rate hiking cycle after their December meeting.

However, he added: “If inflation does not come down as quickly as we expect and the Fed raises rates closer to 5%, it will be difficult to avoid a recession.”

The S&P 500 and Dow Jones Industrial Average fell 1.7% last night as investors digested the increased possibility of rates rising by 0.75% for a fourth meeting in a row in November, as well as the Federal Reserve’s downgraded growth forecasts.

The central bank’s projections now suggest that US GDP will grow just 0.2% this year and 1.2% in 2023, while unemployment will climb to 4.4% from the 3.7% reading in August.

This deteriorating picture comes at a time of already heightened geopolitical uncertainty, the threat of energy shortages in Europe and continued Covid restrictions in China.

In his post-meeting remarks, Powell reiterated that the Fed remains focused on achieving price stability and that this will likely require a sustained period of restrictive monetary policy, sub-trend economic growth and higher unemployment.

Despite the hawkishness of the Fed, Wall Street has tentatively priced in nearly 0.5% of rate cuts towards the end of 2023.

ING’s chief international economist James Knightley pointed out: “The average period of time between the last rate hike in a cycle and the first Federal Reserve rate cut has averaged just six months over the past 50 years.

“Given the risks to growth and the potential for lower inflation, we are forecasting rate cuts throughout the second half of 2023 with our best guess for where the Fed funds rate ends the year being 3-3.25% – more than 100 basis points below where the Fed is indicating.”

For now, the chances of a near-term pivot by the Federal Reserve looks highly unlikely after Powell vowed to “keep at it until we’re confident the job is done”.

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Against this backdrop, UBS’s Haefele advises investors against retreating to the sidelines.

He said this was especially important given the drag on cash from high inflation and the challenge of timing a return to markets without missing out on rebounds.

Haefele recommends staying “invested but also selective”, with a focus on the themes of defensives, income, value, diversification and security.

He adds: “Periods of elevated inflation have historically been associated with outperformance by value stocks relative to growth. We favour global value and the UK equity market, which has a high exposure to value sectors.

“In addition, we expect energy stocks - a value sector with attractive cash returns - to benefit from higher oil prices in the months ahead.”