The Fed raised its benchmark interest rates three-quarters of a percentage point in its most aggressive hike since 1994. Officials also significantly cut their outlook for 2022 economic growth, now anticipating just a 1.7% gain in GDP, down from 2.8% from March. After the meeting we have received the first commentaries from the professionals in the industry, where they reflect their insights and thoughts on the Fed’s statement.
Lale Akoner, Senior Economist at BNY Mellon Investment Management
Central banks are in a tricky situation– growth is slowing down and inflation is persistent- and you have one policy tool (interest rates) to tackle these conflicting forces. This puts the Fed in a tricky situation as yesterday’s 75 bp rate hike will help to bring down inflation expectations but will may increase the pace of the slowdown.
That said, historical data suggest that once inflation went above 5%, it never came down unless the fed funds rate coming above the CPI. Hence, despite the largest hike delivered so far this century the Fed Funds rate remains low, especially compared to the elevated rate of inflation.
This does explain the Fed’s decision to bring rates to restrictive levels this year to tame inflation expectations.To emphasize how tough it will be to get inflation back to the 2% target range from these monthly rates: even if we reverted to monthly growth rates of 0.2% m/m for the rest of 2022 –which is the 5-year m/m average prior to inflation picking up last year- we would still end 2022 at headline ~6% inflation.
In contrast, if monthly rates remain where they are, averaging 0.7% during the past 6 months, then we will hit a new peak by August, just under 9%, and end the year near 10%.
Nicolas Forest, responsable global de renta fija de Candriam
The Fed decided to raise the target rate by 75 bps: this is the largest increase since 1994. The FF rate could reach 3.4% by year end according to the FED new dot plots. They increased their unemployment rate projections from 3.6 to 4.1 next year showing that the goal number one is fighting inflation.
Paradoxically the bonds yields have tumbled despite the hawkish meeting – showing that the FED could tame inflation by the end of 2023.
So it is another step in the monetary tightening cycle. With this big hike, the FED wanted to take back control of the situation. Inflation is becoming the priority despite the risk of a hard landing. The pressure is strong for the ECB and the BOE to follow this normalization.
A clear message from the FOMC that getting into restrictive monetary policy rapidly is strongly favored by the committee in their fight with inflation. Dropping ‘labour market to remain strong’ from the statement is telling, as are forecasts for an unemployment rate at 4.1% (from 3.6% currently) by end 2024.
Historically such an increase in the unemployment rate suggests a recession so it seems the committee are willing to take that risk (although maintain it is not their intention) in a desire for 2% inflation. Chair Powell was clear that they will be flexible dependent on incoming data.
Silvia Dall’Angelo, senior economist at Federated Hermes
It has been a very eventful week for monetary policy, with major central banks now tackling more decisively the issue of elevated inflation – a global phenomenon – and accordingly embarking on steeper normalisation paths for their policies.
Following the hawkish ECB pivot last week and the aggressive move by the Fed last night, the Bank of England also suggested they are ready to step up their efforts to fight inflation. At today’s meeting, the Bank of England increased its policy rate by 25bps to 1.25%, in line with expectations, but the vote split was hawkish, with three officials voting for a larger 50bp move. Importantly, the Bank stressed it is “particularly alert” to signs of inflation becoming more persistent and added it would “act forcefully” on inflation, if necessary. The adoption of this jargon likely preludes to a bigger move on rates at the next meeting in early August, save for unexpected developments in inflation and growth.
Overall, the UK is heading towards a mix of somewhat easier fiscal policy and tighter monetary policy in the second half of this year. Indeed, the recent fiscal package announced by Chancellor Rishi Sunak – due to kick in in July – played a role in allowing the Bank to focus more on inflation concerns and turn more hawkish compared to its previous meeting in May. The Bank estimates the package could lift GDP by 0.3% in the first year. At the same time, while the recent negative news on GDP growth were concerning, the Bank is taking comfort from the strength of the labour market. In other words, it looks like the Bank of England is setting the stage for a larger 50bp rate hike at its next meeting in August, when a new full set of forecasts and press conference will provide an opportunity to better explain the move.
The Fed led the pack by accelerating the pace of tightening and it now envisages a more aggressive pace over its forecasting horizon. The acceleration was justified by recent data on both inflation and expectations, suggesting elevated inflation had become more pervasive and had started to affect long-term expectations more significantly. However, the Fed did not predict a recession. Yet, Chair Powell acknowledged that the path to a soft landing had become much narrower. The fight to inflation is now the priority for the Fed, and if a recession is the price to pay to defend its credibility, the Fed is ready to pay it.
Meanwhile, the ECB is contending with a different set of challenges, namely the fragmentation risk surrounding its policy normalisation journey. The ECB is now set to announce some provision to address fragmentation at its upcoming meeting in July. The design of such a tool is a challenge, given the technical and, more importantly, political constraints the ECB is facing. It will call for a compromise across different components of the Governing Council. Whether such tool will turn out to be effective and credible is yet to be seen. European central banks will have to tread carefully as they deal with a more acute inflation-growth trade-off.
The Swiss central bank (SNB) also surprised the market with the first rate hike in 15 years and made some unexpected strides towards abandoning the negative rate policy that it had adopted in 2015, anticipating the likely ECB moves in coming months. The spectacular SNB’s pivot – now focusing on the fight against inflation rather than on preventing excessive currency strength – is indicative monetary policy globally is likely at a watershed moment.
Jon Maier, CIO de Global X
We know the Fed needs to cool the economy. We already see how by hiking rates, they can cool demand in the housing market. Next, they will work towards raising the unemployment rate. They must bring inflation back closer towards toward their 2% target with the tools at their disposal.
The hot CPI report last Friday highlighted that the Fed is behind the curve. Due to such high inflation, the Federal Reserve (The Fed) concluded their June FOMC meeting and decided to raise their Fed Policy Rate by 75 basis points (bps) to the 1.5-1.75% range. With this increase, market expectations through Fed Fund Futures markets are pricing for the Fed Funds rate to be between 3.5-4% range after the December FOMC meeting
The Fed has cited better economic activity, robust job gains, low unemployment and higher inflation from supply demand imbalances and higher energy prices as the catalysts for this unprecedented move. CPI rose M/M by +1.0% in May, above consensus estimates of +0.7%. This brought annualized CPI to 8.6%, also above the 8.3% estimate. The highest in four decades. At the same time, May PPI was up +0.8% M/M, in line with consensus, and annualized to 10.8%. Prior to the CPI data last Friday, markets were expecting a 50 bp hike for today’s meeting, reflecting how much the high inflation print unanchored policy expectations.
This move has caused a big sell-off in US Treasuries. The yield on the 10YR UST is now about 3.4%, more than double from when it was 1.6% at the start of 2022. The yield curve continues to remain inverted on the 5YR and 10YR and 10YR and 30YR. Both are moderate recession indicating warning signs. As of today, the 1YR US Recession Probability Forecast stands at around 31.5%.
The Committee mentioned they will
- Continue to monitor the implications of incoming information for the economic outlook
- Remain prepared to adjust the stance of monetary policy as appropriate if risks emerge that would hinder them meeting their goals (2% inflation)
The impending and actual moves may already be working, while CPI and PPI numbers were hot, the University of Michigan survey shows that sentiment has reached an all-time low (low numbers are usually during recessionary times) and there are already concerns about a future rise in the unemployment rate. The U of M measures households, so it gives a sense of how people, not economists, are thinking and feeling.
With Quantitative Tightening (QT) under way, and rates meaningfully moving higher, liquidity in the Treasury market is challenging and interest rate volatility has increased. Volatility is likely to remain elevated, particularly if The Fed dials back forward guidance.
Overall, this could be a step in the right direction for The Fed to finally make a serious dent in demand and fight off inflation. Although there will likely be short term pain, the benefits will likely be rewarded in the long term.
Olivier de Berranger, Deputy Chief Executive Officer and CIO of La Financière de l’Echiquier
A 75bp hike for the first time since 1994, adjusted to the surprise of the latest elevated inflation figure, a largely downgraded growth outlook, inflation expectations that have risen slightly again, more rate hikes expected… From this point of view, it is difficult to say that the Fed did not deliver yesterday to fight inflation and made a strong mea culpa for its former inaction.
However, Mr Powell’s speech did not provide that much clarity on the future path of US monetary policy. The Fed is more and more data dependent, to the point that a bad number released a few days before its meeting made it change its mind.
J. Powell’s statement that the path for the US economy is increasingly dependent on exogenous factors that the Fed does not control have further reinforced this impression of uncertainty. That said, this strong action should be a clear sign that if Central Banks were able to do whatever it takes to fight deflation and the consequences of the pandemy, they could do the same to avert inflation. Calming bond volatility should be the first step to stabilize the equity market.
Jonathan Boyar, Principal Advisor to the MAPFRE AM US Forgotten Value Fund
My view as best as possible is to try and filter out the macroeconomic noise. Obviously, there are some genuine problems with inflation which we need to contend with. But as Buffett says, you pay a very high price in the stock market for a cheery consensus.
So, I would look at your investments over three or five years to know if you are getting good, long-term value. It doesn’t seem like we’re going into a deep recession, such as in 2007 or 2018.
So, assuming we’re not going into that type of recession. High-quality companies certainly can go lower than 10%, 20% and 30% from here; who knows, and it’s impossible to say. But it’s one of those things where if someone takes more of a long-term perspective, it’s very difficult to do that in a market such as this, and when you’re losing all this money every day, people’s emotions get the best of them. So now is the time to think about adding and subtracting from your exposure.
Richard Bernstein, CEO de Richard Bernstein Advisors (RBA)
The Fed has been slow to respond and is now playing catch-up a bit. This is typical. The Fed is always a lagging indicator. 75 bp was needed, but the Fed is so far behind inflation the 75 bp vs 50 bp increase discussion was sort of a moot point.
The real Fed Funds rate (i.e., Fed Funds – inflation) remains near historic lows. It has historically been negative when the Fed was trying to stimulate the economy. Every recession in the last 50 years was preceded by a positive real Fed Funds rate.
Therefore, it is hard to argue the Fed is “hawkish” in an absolute sense when the real Fed Funds rate is near-historically negative. It remains more negative today than after the GFC. Even with a 75bp increase and a forthcoming 75 bp increase, the Fed’s own forecast seems to show an ongoing negative real Fed Funds rate.
That forecast of ongoing negative real Fed Funds rate suggests future upside surprises to rate increases can’t be ruled out. We still think an appropriate investment baseline is inflation remains higher for longer than investors and the Fed currently expect.
Keith Wade, chief economist Schroders
The biggest rate hike since 1994 is a taste of things to come, though the Fed faces an anxious wait for evidence that the economy is responding.
US interest rates were hiked by 75 basis points on Wednesday in the biggest move since 1994. The Federal Reserve (Fed) also signalled that future moves would be greater and that rates would rise further than previously expected. The so-called dot plot now has rates rising to 3.4% by the end of the year and to 3.8% by end 2023.
It is quite possible that the Fed would have stuck to its earlier plans of a 50 bps rise had it not been for a double whammy of bad news last Friday. Headline CPI inflation rose to 8.6% and inflation expectations also increased to 3.3%. Fears that inflation has become entrenched and the US is set to experience a wage price spiral were heightened by the figures.
Clearly, the economy will have to slow by more to bring inflation under control and the Fed also downgraded its growth forecasts to less than 2% for this year and next with higher unemployment. The Fed stopped short of forecasting a recession although chair Powell did say that factors beyond its control could make the outcome worse in his post-meeting press conference. He was referring to the Ukraine conflict and the risk of even higher commodity prices.
We had already expected policy to be tightened aggressively this year in our recent forecast update, although the pace of rate rises is now looking steeper. Nonetheless, we still believe that evidence of weaker activity and inflation will cause the US central bank to slow the pace of tightening and pause early in 2023.
Consumer spending is grinding to a standstill as higher prices cut real wage growth. Inventory levels have built up as unsold goods remained in the warehouse. The latest estimate from the Atlanta Fed is for growth of zero in Q2, bringing the US economy to the verge of recession after a negative reading in Q1. The labour market will also need to cool but weaker sales will cause firms to slow hiring as profit margins come under pressure.
As a consequence we would expect to see inflation easing later in the year and for the tone of Fed announcements to soften. Rates are more likely to be falling than rising by the end of 2023 in our opinion. In the meantime though further tightening lies ahead and an anxious wait for evidence that the economy is responding.
Christian Scherrmann, U.S. Economist
In line with the recent shift in market pricing, and against its previous guidance of 50 bps, the Fed increased policy rates by 75 bps to a range of 1.50-1.75 percent in today’s June meeting. At the same time FOMC members significantly increased their outlook for policy rates, pointing to a federal funds rate of 3.4 percent as soon as the end of this year and a rate of around 3.8 percent at end-2023. Despite this sizable increase, the outlook for the long-run policy rate remains at 2.5 percent.
The Fed also firmed its language in the statement, committing itself to “returning inflation to its 2 percent objective”. And it will do so even if the victory comes at a price: FOMC members now project growth at only 1.7 percent this year and a steady increase in the unemployment rate to (a still modest) 4.1 percent in 2024.
This forecast does not yet paint in a recession, but the Fed’s sudden application of the monetary brakes is going to be hard on the economy. In the press conference Fed Chair Jerome Powell said the latest upward surprise in May’s inflation was the main reason for the increase by more than the 50bps that the Fed had previously suggested and said that both 50bps and 75 bps were possibilities at the next meeting.
Overall, it’s clear that the Fed is determined to regain its inflation credibility and keep inflationary expectations well anchored. It is pushing ahead fast now with much tighter monetary policy in order to get back ahead of the curve. With CPI inflation at an embarrassingly high 8.6% and in danger of going still higher, the Fed probably feels it has no alternative. Its reputation has been tarnished. It therefore also has no alternative now but to follow through on its hawkish guidance – even if a recession is the ultimate outcome. The chances for a recession have clearly risen now even further.
Kelly Chung, Investment Director and Head of Multi-Assets at Value Partners
The Fed was ‘a bit late’ in tightening the policy, which made inflation out of control in the short term. In addition, inflationary pressures were heightened with the increasing military tensions between Russia and Ukraine, pushing up energy and food prices further.
Commodity prices will likely remain high in the second half of this year due to a possible escalation of the war between the two countries, implying that higher inflation will remain. With persistently high inflation and ongoing political risks, the overall economy is expected to fall into a recession.