The Fed could start cutting rates in the summer, Pantheon says, providing a boost to markets

• A Fed pivot to interest rate cuts could come in the summer, according to Pantheon Macroeconomics.
• A Wednesday note predicted the central bank will issue a final rate hike in January, slowing further to 25 basis points.

The Federal Reserve could pivot to interest rate cuts by the summer after slower increases earlier this month and next month, according to Pantheon Macroeconomics.

In a Wednesday note, Pantheon gave a weaker outlook for the first half 0f 2023, forecasting a higher chance for a brief recession next year amid higher rates, widening corporate spreads, lower stock prices, home prices rolling over, and the strong dollar.

And because "policymakers are slaves to the data," Pantheon expects the Fed to be less hawkish than expected and foresees a final rate hike in January of 25 basis points, though another 50 basis points is possible.

The Jerome Powell-lead central bank hiked benchmark interest rates by 50 basis points last week, after four consecutive hikes of 75 basis points. But he remained hawkish in his remarks following the latest rate hike, and didn't rule out future increases.

"Markets increasingly appreciate that the Fed's actions have limits, despite Chair Powell's uncompromising rhetoric," Pantheon said.

The note also sees an increase in labor participation next year, which will drive up unemployment and stifle wage demand, easing inflationary pressure.

"The Fed already has pivoted to smaller hikes, but the next pivot — to stopping the rate hikes altogether — will be more consequential for markets," Pantheon said. "The final pivot, to signalling lower rates, likely will be a story for the summer, but is entirely contingent on the Fed seeing clear evidence that wage growth is moderating. We think that's a good bet; jobless claims are creeping up, and hiring indicators are softening."