Please see below an article received from Evelyn Partners earlier this morning (27/07/2023), which details their thoughts on yesterday’s interest rate decision that was announced by the Fed:
What happened?
After pausing in June, the FOMC raised its upper bound interest rate by 25bps to 5.50%, which is broadly in line with what the market had expected, and is at its highest level for 22 years.
In the following press conference, Fed Chair Powell did leave open the possibility of further hikes to return inflation to its 2% goal. This means the next FOMC on 20 September is a “live” meeting. As of today, the Fed Futures market is not expecting a full 25bps rate hike in September.
What does it mean?
Unless there is a material rebound in inflation, the Fed is set to pause on interest rates from here, with the next move likely to be down sometime in 2024. Importantly, favourable macro data over the last few months should leave the hawks at the FOMC in the minority, reducing the risk that the Fed goes on to overtighten on interest rates.
First, the June CPI inflation report showed that underlying price pressures continue to subside. All three of the main core inflation categories that the Fed is focusing on, such as housing, core services ex shelter and core goods, are all trending down on an annual basis. Consumer surveys of inflation expectations are also coming down, which will be encouraging for the Fed in its efforts to prevent inflation becoming entrenched in the economy.
Second, the jobs market is cooling. At the headline level, June non-farm payrolls came in at 209k, its lowest increase since the recovery from the pandemic. Importantly, firms are cutting back on job vacancies and this is reducing the number of workers willing to quit jobs to seek higher paying opportunities. In effect, the Fed appears to have reduced the risk of a price-wage spiral that would make its job to bring down inflation more difficult. The next key data point to determine the whether wage rates have indeed peaked is the second quarter Employment Cost Index (a comprehensive measure of wages and benefits) due on the 28 July.
Third, the FOMC will be cognizant of the impact of monetary tightening on the financial system. Back in March, the failure of Silicon Valley Bank (SVB), the 16th largest bank in the US, raised concerns of systemic problems appearing, like those suffered during the Global Financial Crisis (GFC) in 2008. However, those fears proved to be unfounded as SVB was more of a manageable idiosyncratic risk. Nevertheless, further monetary tightening could potentially lead to rising debt default rates in the private sector that leads to material financial and banking sector stress.
Bottom Line
With the Fed set to pause on interest rates, it provides an opportunity for equities to continue to broaden out from the Artificial Intelligence-led rally.
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Carl Mitchell – Dip PFS
Independent Financial Adviser
27/07/2023