Fed-funds rate could end up as high as 5%, says overseer of $1.3 trillion in assets

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In the run-up to Wednesday’s policy announcement by the Federal Reserve, SEI, an overseer of $1.3 trillion in assets, sees a likelihood that the central bank’s hiking cycle will end at a level that leaves interest rates twice as high as they are now.

The Oaks, Pennsylvania-based firm sees a “reasonable base case” that the level at which Fed officials will stop hiking rates is between 4.5% to 5%, according to chief market strategist Jim Solloway. That’s double the current level between 2.25% and 2.5% and above the 4.25% to 4.5% range that traders are mostly expecting for year-end, though it’s not far from where market expectations are increasingly heading for next year, according to the CME FedWatch Tool.

For now, the broader financial market has remained focused on the likelihood that Wednesday’s rate hike will be 75 basis points, plus the slim chance it might be a jumbo-size full-percentage-point hike — which would push borrowing costs into a range that’s at or above 3%. Generally speaking, investors have yet to fully wrap their heads around the risk of a 5% level by next year. Policy makers’ updated projections, released on Wednesday, will signal how much higher they’re willing to keep pushing rates next year and over the long run.

Some — like Paul Ashworth, chief North America economist for Capital Economics — still see the possibility that the Fed could shift back to smaller increments of hikes after Wednesday’s widely expected move, under the assumption that inflation should ease soon. However, inflation has proven to be stubbornly persistent, and if the Fed pencils in further rate hikes for 2023, that could easily push the fed-funds rate target above 4.5%.

“Given our view for continued resilience in U.S. economic growth and higher-for-longer inflation, the Fed will need to keep raising rates into 2023,” SEI’s Solloway wrote in an email on Tuesday. “A peak funds rate of 4.5%-to-5% is a reasonable base case, but the risks appear skewed to the upside.”

SEI isn’t alone in its views. U.S. economists at Deutsche Bank, Wall Street’s most pessimistic bank, expect the Federal Reserve to end its rate-hike campaign at 4.9% in 2023’s first quarter. Meanwhile, strategist Philip Marey of Dutch financial-services company Rabobank expects the fed-funds rate to peak at 5% next year, and doesn’t expect the Fed to pivot from its rate stance before 2024.

U.S. stocks finished sharply lower ahead of Wednesday’s policy update from the Fed, with Dow industrials DJIA, -1.01% ending down by more than 300 points. Meanwhile, most Treasury yields continued to climb, with the 10-year rate TMUBMUSD10Y, 3.536% hitting a fresh 11-year high of 3.57%.