We see an overlooked risk that the Fed will hold rates higher even through a recession

The US benchmark interest rate will reach 3.75% by December, but Fed policy in 2023 hinges on an uncertain inflation outlook

We expect the US Federal Reserve to raise rates to 3.75% by December. While rate cuts are a notable possibility by mid-2023, we also see a widely overlooked risk that, with inflation fears dominating, the Fed will hold rates above 3% even through a mild recession. This will weaken the growth outlook through 2023 and into 2024. MNCs should adjust their capital budgeting and liability management accordingly. MNCs should also plan for the potential impacts on rate-sensitive clients, suppliers, and consumer sectors. Housing, construction, and autos all stand to lose from sustained higher rates.


The Fed hiked its benchmark interest rate by 75 basis points at its July 26–27 meeting, following a 75-basis-point increase in June—the largest rate hike since 1994. The upper bound of the federal funds rate now stands at 2.50%.

As a base case, FrontierView anticipates further acceleration in the US inflation rate until September, followed by stabilization or a slight easing in the fourth quarter. Under those circumstances, we expect the Fed’s hikes to slow slightly in Q4, leaving rates at 3.75% by December. After this, the Fed outlook becomes more uncertain and dependent on the state of the economy—primarily the trajectory of inflation.

Overall, inflation is likely to remain elevated through 2023 due to shortfalls in US labor supply, as well as myriad global headwinds, including ongoing risks coming from the war in Ukraine and China’s economic policy, tight commodity supply, and lasting supply chain disorder.

Our View

With high uncertainty over the path of inflation and the Fed’s response, we have outlined three principal scenarios for Fed policy in the next 18 months. These scenarios encompass a range of possible macroeconomic developments.

Overall, we see it probable the Fed will hold rates well above 3% even in the likely event of a US recession beginning in H2 2022. Although the Fed has dropped rates in every US recession of the last few decades, the last 40 years have also coincided with a long, historic disinflationary trend that appears to be reversing. The Fed is no longer operating from the playbook of the last 20 years where it cuts to near 0% at the first sign of recession. Fears of 1970s-style stop-start inflation could keep the Fed in a tougher posture for longer.

Base case – “Higher for longer” interest rates (50% probability): After reaching 3.75% in December, the Fed pauses in response to signs of stabilizing inflation and slowing growth. As it becomes clear a recession or slowdown is mild (with unemployment rates staying below 4.2% and quarterly (SAAR) GDP contractions of only ~0.5%), the Fed holds rates above 3.25% through 2023, with only one 25-basis-point rate cut across the year. This rate path is consistent with either a higher growth, easing inflation scenario (in which the Fed feels justified in keeping rates elevated in line with resilient growth) or a lower growth, higher inflation scenario (in which the Fed feels compelled to keep rates elevated due to stubbornly high inflation, but does not raise rates higher in 2023 due to a deteriorating growth outlook). 

“Dovish surprise” scenario (30%): As global recession drives easing food and energy prices, inflation shows signs of consistent monthly falls, giving the Fed room to pivot toward rate cuts beginning in March. This scenario becomes more likely in the event the US economy enters a deeper recession, with unemployment rising above 4.3% or annualized QOQ GDP contractions of more than -1.5%. Alternatively, this scenario may arise if the Fed opts to quietly drift from its 2% inflation mandate and settles for month-on-month inflation increases below 0.2% as justification for dropping rates in response to a recession.

“Hawkish surprise” scenario (20%): Further upward surprises in inflation—driven by increases in rent, services, and core goods inflation and/or further energy and commodity supply disruptions—scare the Fed into hiking rates beyond 4.5%, which it holds through 2023. Although this scenario was unthinkable several months ago, recent statements by Fed officials have made clear their intention to hike rates as high as necessary to bring inflation down, even at the expense of growth and employment. Any further inflation shocks, particularly those stemming from exogenous global supply shocks, make this scenario more likely.

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