The much-awaited Federal Reserve (Fed) monetary policy decision triggered volatility in financial markets. While the outcome was widely expected (i.e., Fed hiking the funds rate by 25bp), the press conference turned out to be more important for markets than the actual hike.
It makes sense, given the forward-looking nature of markets.
With yesterday’s hike, the funds rate reached 4.75% – a stunning level compared to where it was only a year ago. Is the Fed done with tightening? Unlikely.
Yet, markets cheered the Fed’s decision.
US 10-year yields plunged 11bps. Moreover, Nasdaq jumped more than 2%, despite the hawkish Fed statement.
The reason – a dovish presser.
A couple more rate hikes to follow
The first thing to draw attention to yesterday’s Fed decision was that rate hikes are not over. The Fed is still far from the terminal rate, as Chair Powell suggested a couple more rate hikes to follow.
It means that the Fed sees the terminal rate at 5.25%, given that the base case scenario is that it will hike twice by another 25bp each time.
But the big question to markets was – will the Fed start rate cuts in 2023?
No 2023 rate cuts
The answer to the previous question is no.
Therefore, after the funds rate reaches 5.25% in twelve weeks, the Fed is set to pause its tightening cycle. No rate cuts this year, but things can change in a blink of an eye should we see a recession in the second half of the year.
Markets don’t need more. Merely the hint of a rate hike at the start of 2024 would be enough to send stocks higher in the second half of 2023. As such, the “no 2023 rate cuts) the message was not interpreted as hawkish as it would otherwise be.
A disinflationary process has started
The biggest news of yesterday’s presser was coming from the inflation front. Fed’s Powell said that a disinflationary process has already started.
That single mention triggered a wave of US dollar selling. Stocks rallied too.
It means that the Fed believes inflation has peaked, albeit there is much more work to do on this front.
In short, the rate hikes are making their way into the economy, and inflation is coming down. A soft landing for the US economy is not the base case scenario.
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