6 2023 OUTLOOK The Fed’s Battle Isn’t Over The Fed increased interest rates another half percent to a target rate of 4.25% to 4.50% in December, after headline inflation slowed in October and November. With the central bank hiking at a slower pace, the focus is turning to when the rate cycle may come to an end. In prior tightening cycles, the cycle ended when the federal funds rate was greater than the inflation rate. With the current inflation rate nearly three percentage points above the fed funds rate, the Fed likely has more work to do. We expect the fed funds rate to peak around 5% by the middle of next year. While market consensus has priced in interest rate cuts by the third quarter of 2023, we think the Fed is likely to hold rates steady after its final hike. Exhibit 4: The Fed Has More Work to Do Exhibit 4: Fed Has More Work to Do “We think the Fed Fed funds rate and inflation (%) at the end of prior tightening cycles is more likely to 25% Fed funds CPI inflation hold rates 20% steady 15% after its final hike.” 10% 5% 0% Source: Strategas. As of December 14, 2022. WI-318491 4 At the center of the Fed’s battle against inflation is the U.S.’s chronic shortage Source: Strategas. As of 12/14/2022 of labor. Better-than-expected gains in both wages and employment in November underscored the labor market’s resiliency. While goods prices have declined, and the housing market’s sharp downturn should soon be reflected in inflation through lower shelter costs, a strong labor market continues to add to inflationary pressures. Inflation should continue to decelerate in 2023, but it’s unlikely to reach the Fed’s target of 2% until at least late 2024. BNY Mellon Wealth Management’s forecast is for the headline consumer price index to fall to 4%-5% by the end of 2023.