Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, DC, on 22 March 2023. AFP.
The Federal Reserve lifted its fed funds interest rate again to curb inflation as we expected by 25bps to 4.75-5.00% as the chart shows. But the Federal Open Market Committee meeting was dovish with the Fed more cautious than before.
Firstly, the FOMC signalled it was close to the end of its year-long interest rate tightening cycle. The Fed dropped its view that for the fed funds rate: "ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time." Instead, it only said: "the Committee anticipates that some additional policy firming may be appropriate."
Secondly, in their new forecasts, FOMC members on average only saw one more 25bps increase in the fed funds rate to reach 5.00-5.25% this year.
Lastly, the Fed said this month’s bank failures and fears other banks may struggle would likely hurt growth: "the U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation." Chairman Powell said a pullback in lending may result in the Fed having to raise interest rates less to curb inflation: "monetary policy may have less work to do."
With the Fed more cautious, we forecast only one more rate hike now in May. We lower our forecast for the peak in fed funds to 5.00-5.25%.
Source: Bank of Singapore, Bloomberg.
We also think core inflation will stay above the Fed’s 2% target at the end of 2023 and 2024 at around 3.5% and 2.5% respectively as the FOMC also forecasts. Therefore, we only see the Fed starting to cut interest rates from March 2024.
Our base case thus still sees stubborn inflation, tight monetary policy and now tougher credit conditions causing a US recession later in 2023. We therefore lower our longstanding forecast for 10Y Treasury yields over the next year from 3.50% to 3.25% as financial markets are likely to switch from focusing on inflation to fearing recession.
We thus think investors should remain cautious on risk assets. We expect a weaker USD is likely as Fed rate hikes peak and we continue to favour US Treasuries and high-quality corporate bonds as safe-haven hedges against recession risks.
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