Traders wagering this week on the Federal Reserve lifting its benchmark interest rate to 6% are still aiming way too low, according to Dominique Dwor-Frecaut.
Dwor-Frecaut, a senior market strategist at the research firm Macro Hive, says the Fed will have to boost the federal funds rate to about 8% to win its battle to bring inflation fully under control. That’s based on her analysis using a Taylor Rule model with data stretching back to 1970.
She’s not fazed by the fact that her call is still very much an outlier. She first made this prediction not long after the Fed started its tightening cycle in March 2022. For traders, she warns that two-year Treasury yields are headed well above 6%, and the yield curve will become even more inverted than it is now.
“I’m even more confident about my 8% call after the nonfarm payrolls report,” Dwor-Frecaut, who previously worked in the New York Fed’s markets group, said in a telephone interview, referring to surprisingly-strong employment data published on Feb. 3. “The funds rate has to go much higher than is now predicted. Policy is still very easy.”
While Dwor-Frecaut may be in a minority on Wall Street, others have floated similar ideas. Former Fed Presidents Jeffrey Lacker and Charles Plosser wrote in a recent Wall Street Journal opinion piece that, if inflation stays where it is now, typical policy rules would recommend a rate between 6.5% and 8% by the end of the year.
For now, though, overnight index swaps are priced for a peak in the federal funds rate of about 5.1% in July, and then cuts to around 4.8% to close out 2023. The hot jobs report brought market pricing for the so-called terminal rate in line with Fed officials’ own estimates: In December, they published projections suggesting they expected to raise the federal funds rate to 5.1% this year, according to the median estimate, though they didn’t see any rate cuts until 2024.
