Federal Reserve Board Chair Jerome Powell speaking at the Federal Reserve on 01 February 2023. AFP.
Federal Reserve Board Chair Jerome Powell speaking at the Federal Reserve on 01 February 2023. AFP.
The S&P 500 rallied 1%, 10Y Treasury yields fell 10bps to 3.40% and the EUR rose to 1.10 against the USD after the Fed’s latest meeting.
As was widely expected, the Federal Open Market Committee (FOMC) slowed its pace of interest rate rises by lifting its fed funds rate 25bps to 4.50-4.75%. In December, the Fed had hiked by 50bps to curb inflation and in its prior four meetings by 75bps each. But FOMC members now want to assess the impact of last year’s rapid tightening on the US economy so officials signalled beforehand the Fed would slow to 25bps rate hikes at its upcoming meetings this year.
Chairman Powell, however, surprised investors by failing to push back against dovish perceptions that the FOMC’s tightening was now effectively over. Core inflation – using the Fed’s target measure – has fallen from a peak of 5.4% last year to 4.4% now. Additionally, the chart above shows recession fears are rising after January’s manufacturing ISM survey last night fell further to 47.4 and therefore is at levels that indicate activity is contracting. Thus, financial markets are now pricing the Fed stopping its rate hikes below 5.00% in the first half of the year and also anticipate rates being cut in the second half.
In his press conference, the Fed Chair only said he was “not going to try and persuade people” who had a different outlook. He also observed he was “not particularly concerned” about the financial markets’ pricing of future interest rates.
Source: Bank of Singapore, Bloomberg.
Powell’s surprisingly hands-off remarks spurred risk assets to rally sharply overnight. We are more cautious, however, and see at least two more 25bps rate increases this year to bring the fed funds rate up to 5.00-5.25%. We also do not expect any interest rate cuts later this year despite recession being likely in the second half.
Firstly, the FOMC statement was more hawkish, reiterating that “ongoing increases in the [fed funds] target range will be appropriate … to return inflation to 2% over time.”
Secondly, Powell warned “restoring price stability will likely require maintaining a restrictive stance for some time … I just don’t see us cutting rates this year”
Lastly, the US labour market remains too tight for the Fed to achieve its 2% inflation target. Overnight, December’s JOLTS job openings jumped to just over 11 million vacancies. Thus, more rate hikes will be needed to slow wage growth and reduce the economy’s overheating.
We therefore remain concerned that it is too early for investors to forget about the risk of more Fed rate hikes, let alone price in rate cuts this year. A worse than expected monthly inflation print or a strong payrolls report in the next few months could lead to financial markets having to revise their expectations for the fed funds rate sharply higher again to the detriment of risk assets.
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