Though markets call the Fed’s bluff over rate hikes, the Fed still has concerns about softer inflation.
At the FOMC meeting on Wednesday, the Fed decided to lower rates and raise them by 25 basis points. This was the most recent step in the battle against inflation that has been persistently high for years as policymakers are ready to stop the rapid rise in the benchmark interest rate at a level that is regarded to be “sufficiently restrictive.”
In the press conference, Jerome Powell said that the committee has not yet decided where the policy rate would end up but that it is still open to “ongoing rises.” Powell went on to say that “we’re talking about a few more rate hikes to get to an appropriately restrictive posture.” This forecasts a further 25 basis point increase in March and May, bringing the Fed Funds rate to 5.00–5.25% and in line with the Fed’s median dot plot estimates of 5.1%.
Markets, however, disagree. In reality, the Fed’s admission that “inflation has moderated slightly but remains elevated” was all that was required for dovish bets that the Fed won’t raise over 5% to increase, and the indicated rate below, obtained from Fed Funds futures, even predicts the first rate decrease in the second half of the year.
After the delivery of the announcement, risk taking increased, and what had first seemed like a positive breach of long-term trendline resistance in US stocks is now setting up for a trend reversal as the S&P 500 hit a 20% rise off its October low – a hallmark of a technical bull market.
The action seems to dispel worries of a US recession, which have not yet been allayed despite US GDP figures showing two consecutive quarters of improvement for Q3 and Q4. Despite forward projections of higher rates in the future, US yields and the currency slipped and now seem vulnerable to additional falls. Rate increases, even if they are modest.
The Bank of England suggests a rate pause but leaves room for more rate increases.
Given the gloomy economic forecasts and the potential for double-digit inflation, the Bank of England continues to be a more hesitant rate hiker than its counterparts. The monetary policy committee (MPC) altered prior wording from its report that, at the time, suggested that rates would be raised further. Phrases like “it will respond strongly” and “additional rises in bank rate may be necessary” suggested a potential halt, which caused sterling to fall.
That the Bank anticipates a smaller economic downturn over a shorter time period than before is some good news, or should I say “less bad news.” However, this only provides a bright spot for the faltering economy and does not provide the Bank additional discretion to raise rates.
A pretty good rebound in GBP/USD from the low levels observed during the brief period of the Liz Truss administration came to an abrupt end when news of a potential pause brought UK Gilt rates down across many categories (primarily the 2 and 10-year yields). All things considered, the outlook for the pound is not favorable, but this usually serves to support the local FTSE 100 index, which continues to gain from its composition of mining and oil businesses, which continue to make enormous profits, and its absence of IT stocks.
The 50-basis point increase announced yesterday was swiftly communicated by the ECB governing council members in the run-up to the meeting, so it came as no surprise when the news leaked. Anyone who had any doubts about how much the ECB intended to raise rates moving ahead should have had no such doubts after hearing ECP President Christine Lagarde reiterate the need to keep raising rates rapidly.
Additionally, it was resolved that the Bank should begin gradually winding down its stimulatory bond-buying programs. The December guidance that certain ageing instruments would not be reinvested, often called as tapering, was reiterated.
Soon after the meeting, 3.5% was offered as the preferred terminal rate by the infamous “ECB sources,” which are anonymous leaks from certain council members who do not want their names known (one percentage point above the current level).
A sudden change in attitude and confidence in Europe’s slightly more resilient economy, coupled with a widening interest rate gap with the US, portends favorably for the future of the euro. As US yields continue to decline, German bund rates have lately increased.