Please see the below article from Evelyn Partners providing their thoughts on the FED’s decision to hold interest rates at their present level. Received this morning 15/06/2023.
What happened?
The Federal Reserve met yesterday and chose to hold rates at their current level, for the first time after 10 consecutive meetings where they made increases. This was in line with the market expectations and means the target range remains 5% – 5.25%. The Fed also published their quarterly ‘dot plot’ which shows where committee members see rates heading in the future. It showed rates peaking this year at a level of 5.6%, which is approximately 50 basis points higher than they had been expecting at their March meeting. Expectations for the year end 2024 and 2025 were also revised higher, to median values of 4.6% and 3.4% respectively.
What does it mean?
The long awaiting Fed ‘pause’ has finally arrived, but in rather more hawkish fashion than markets might have expected. The updated dot plot reveals that federal reserve officials expect not one, but two more rate increases before a peak in rates by the end of the year.
Economic data has generally been stronger than expected. Inflation, particularly the ‘core’ excluding food and energy figure, has not fallen away as quickly as some officials had expected, and the jobs market remains extremely resilient. The Feds own projections released yesterday revealed a more negative outlook for inflation and more positive stance on the growth and jobs.
The contradiction of not increasing rates at this meeting but signalling more to come was difficult to communicate in the press conference which followed the meeting. Federal reserve chair Jerome Powell said that pausing at this juncture would give the committee “more information to make decisions” and would “allow the economy a little more time to adapt as we make our decisions going forward”. He also said that he expected the next meeting in July to be a “live one”, sending an indication to markets that an increase is likely then.
Committee members of a more dovish outlook likely remain concerned about the recent failure of three mid-sized banks, which began with troubles at Silicon Valley Bank in March. Powell sounded a note of caution on this yesterday, saying “We don’t know the full extent of the consequences of the banking turmoil we’ve seen”, adding “It would be early to see those”.
Market expectations before the meeting were that there would likely be one further rate hike, so there was some surprise as a further increase was priced in. 2 year treasury bond yields, moved up nearly 20 basis points on the announcement before settling back slightly. The US dollar strengthened relative to sterling by about half a cent and the equity market fell before regaining previous levels.
Bottom Line
The Fed has stopped hiking rates, but only momentarily, signalling to markets that two further 25 basis point rises can be expected before the end of the year, to tame inflation which is not falling as fast as officials has hoped.
While these developments look slightly contradictory, it does give the Fed maximum flexibility for where policy goes from here – if there were to be some big development in the data in the coming months, they can change course.
From our perspective, little has changed – the Fed is close to the top of its interest rate hiking cycle, meaning a headwind for bonds and more interest rate sensitive areas of the equity market will subside.
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Alex Clare
15/06/2023