15 JUN, 2023
By Leticia Rial from RankiaPro Europe
The US Federal Reserve has opted to halt interest rate hikes and keep interest rates in a range between 5% and 5.25%. This decision comes after ten consecutive rate hikes since March 2022, marking a historic milestone. According to the statement released yesterday, the Fed notes that recent indicators point to steady economic growth at a moderate pace, with solid employment growth in recent months and a low unemployment rate.
Despite this pause, the US central bank does not rule out future rate hikes given the resilience of the economy, especially in the labour market. Here are the first reactions from investment fund managers.
As expected, the Fed took a pause from tightening its monetary policy further in tonight’s meeting. However, the strong message was that more tightening lies ahead as indicated by the move-up in the 2023 dot plot, and was confirmed by Chair Powell during the press conference. The policy emphasis remains on price stability and the ongoing resilience in the labour market continues to be seen as driver of persistence in inflation. With additional hikes predicted, the FOMC maintains its higher for longer policy stance, believing it will put downward pressure on price pressures.
All in all, we maintain our view a recession is likely in late 2023 or early 2024, as the tight policy starts to damage the economy going forward. The transmission lags in this cycle have been long and variable due to the COVID shock, however, the continued focus on keeping monetary policy tight means risk to growth remains firmly to the downside as we move further into 2023.
The Fed has decided to be on a pause in June at 5.0%-5.25%, but the FOMC has opened the window for potential two other rate hikes over the rest of this year. According to the Fed, risks remain on the upside on inflation, while economic forecasts for this year have been adjusted higher on growth, inflation and lower on unemployment rate.
M. Powell recognized the FOMC has underestimated the resilience of the activity and also overestimated the time of response of services to rate hikes. In July, data should bring more comfort on disinflation process, but still relatively strong data from services and labor. As seen in the surprising rise in the Dot plots, reflecting governors’ projections of key rates, data should not yet comfort the most hawkish members within the FOMC to stay on a pause. Uncertainties could remain in place for the next September meeting, even if M. Powell will force the pause. This should leave uncertainties about a potentially unfinished Fed’s job on inflation and non-definitive pause on key rates.
The lesson from past rate hikes and uncertainties surrounding next FOMC decisions is the FED will take time before easing its policy next year. Money markets are pricing rate cuts in Q1-24, but the FOMC should wait for more comfort on a real disinflation trend on both labor and services before rejuvenating the economic cycle.
The Fed took a breather at its meeting today, breaking a run of 10 consecutive rate hikes which have pushed the Fed Funds Rate 500bps higher since the start of last year. Clearly there is a desire to see how the tightening delivered is affecting growth and inflation, especially given uncertainty over how aggressively and quickly this will bite.
However, updated interest rate forecasts from the FOMC today have penciled in another 50bps of rate hikes this year, meaning this pause might prove short lived. Indeed, absent some deterioration in activity, or a clearer deceleration in underlying inflation, it seems likely that the Fed will be back to tightening in July, or latest September.
The FOMC met with the majority of market expectations by holding rates steady at this meeting at 5.25%. However, their underlying tilt was still very hawkish with the median forecasts for this year moving to a suggestion of 2 further rate hikes down the line, albeit contingent on the economic data as it comes in.
No doubt this was to ensure the market received the message that the risks for rates were asymmetrically skewed to the upside still and likewise they did not want to see the market post a dovish reaction and to ease financial conditions further at this point in time. Regardless of this, this is the first pause after 500 bp of rate hikes over the past 14 months and signals at the end to the cycle is nigh, if not yet quite here.
This process of keeping conditions tight whilst moving to a pause in due course is exactly what policy makers would look to engineer as they do not want easier conditions yet. That said a 100 bp of rate cuts is expected by the FOMC in 2024, so whilst we may not yet have turned the corner, the end to this cycle is imminent.
We would expect the long end of yield curve to continue to perform well for now in this context and for the curve to remain heavily inverted.
As we expected, the Fed backed away from hiking another 25 basis-points at its June meeting. The hawkish surprise was delivered in their Summary of Economic Projections as FOMC-members indicated that two additional rate hikes might be needed by the end of 2023. This judgment comes on the back of their assessment of somewhat higher core inflation and more growth in 2023, as well as some more resilience in the labor market. For 2024 and 2025, central bankers did not change much in their economic assessments but also indicated a preference for somewhat higher rates than before. A very hawkish message indeed, while actually doing nothing. The obligatory press statement, which reflects the consensus among central bankers, meanwhile did not change materially, casting first doubts on the hawkish message.
Fed Chair Jerome Powell reiterated the willingness of participants to further increase rates while it was judged as “prudent” to wait and see this time – in the end, the dot plot is not a plan and decisions will be agreed meeting to meeting, he added. While there was no discussion on how the intended two hikes will be delivered, Powell reiterated the meeting-by-meeting approach with July surely being a “live meeting”.
We should keep in mind that their individual projections tend to change quickly and rarely reflect the ultimate outcome. For communication purposes, however, central bankers use those projections to telegraph their mood at a particular point in time, without making an outright commitment on future actions. And indeed, given that financial conditions tend to ease quickly if central bankers pivot away from hiking, a pause on rate hikes must be delivered in with care. In other words, better make sure that actually doing nothing does not counteract your past efforts to slow economic activity. There are also learnings from past meetings, where commentators saw Jerome Powell commit dovish communication errors.
Given the recent optimism in equity markets, maybe central bankers felt compelled to push-back investors while actually doing nothing. Bond investors, at the time of writing, did not buy into two additional steps – instead still pricing in only one – but no longer expect rates cuts this year either. Maybe, after all, their approach did the trick to implement the expectations of “higher for longer”. We stick to our expectation of one more rate hike this year and would like to highlight that our probability of a severe recession did not increase post meeting.
By RankiaPro Europe