The Fed has announced that will raise its benchmark federal-funds rate by a quarter percentage point to a range between 0.25% and 0.5%, this will be the first raise they will make since 2018. They now see its policy rate hitting 1.9% by the end of this year, jumping to 2.8% in 2023 and staying at that level in 2024. Rates at 2.8% would start to dampen economic growth, according to Fed calculations. Due to the crisis in Ukraine, and the high inflation, there is a sense of uncertainty, and Jerome Powell believes that this crisis will keep boosting inflation, and affecting the US Economy in the short run due to the oil prices.
At the same time yesterday, Ukrainian President Volodymyr Zelensky delivered an online speech in front of the members of the US House and Senate, and on a statement made by Biden’s administration yesterday, they stated that they have approved an additional $800 million in assistance to Ukraine.
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.
Paolo Zanghieri, senior economist at Generali Investments
The Fed beefed up its hawkish rhetoric by signalling a rather frontloaded path for the Fed funds rate, consisting of seven hikes this year. Fighting inflation will require to lift the policy rate 40 bps higher than its estimated value by the end of 2023. The risk of triggering a recession by doing so are not large according to the FOMC.
In fact, prompt action against inflation is crucial to keep expectations anchored, and this will allow the economy to maintain the unemployment rate at a record low of 3.5% (well below the 4% equilibrium level) for three year without triggering a surge in prices.
The press release reflected the normalisation start from a solid economy, with employment enjoying a substantial momentum. References to the risks related to new virus waves have been dropped, replaced by an acknowledgment of the uncertain situation following the Russian invasion of Ukraine and the risks for inflation (see the comparison with January attached)
In the press conference chair Powell reaffirmed a high degree of confidence in the healthy state of the economy and some concern for the risk of a labour market overheating. The Omicron variant has delivered only a mild and short-lived slowdown to activity, which is benefitting from a strong labour market and healthy private sector balance sheets. Therefore, the economy, in Powell’s words, can “flourish” also with less monetary accommodation. The cut in the 2022 growth projection from 4% to 2.8% was motivated by the impact of the war in Ukraine. Still, growth is and will remain until 2024 above trend.
Supply and demand imbalances are evident in the labour market with more than 1.7 job offers available for any unemployed person. Therefore, wage growth is at present not consistent with stable inflation. Looking at the past cycle, a “hot” labour market will prop up participation, but some moderation in demand will be required to tame inflation.
Prices increase is expected to remain strong in the first half of the year with the spike in commodity prices and persistent bottlenecks in goods leading to a delay in the peak, and risks remain tilted to the upside. High inflation harms especially low income households and stand in the way of the wage moderation required to keep unemployment low.
Powell noticed that a substantial number of committee members see more than seven hikes this year. He denied that any decision on the path of hiking was taken, but reminded that any of the remaining seven meetings of the year is live, and did not rule out the possibility of a 50bps rise in the future. He noticed that the hawkish pivot announced last year has already filtered into tighter financial conditions (our index is back to its long term value) but some further reduction in accommodation would be welcome. Despite having a similar view on the growth outlook for this year, we think that the economy can withstand a slightly lower degree of tightening and continue to pencil in a maximum of six rate rises this year.
James McCann, Deputy Chief Economist, abrdn
The Fed is behind the curve, and yesterday’s meeting shows a central bank rushing to catch up. It signalled that rates will rise at every meeting this year, and potentially more if inflation does not behave.
Certainly, Chair Powell flagged downside risks from the Russian invasion of Ukraine, but the Fed looks laser focused on getting inflation back to target, raising a high bar for this adjustment to be blown of course.
The message from the Fed was that the economy can handle this adjustment, though we expect higher rates to prove more disruptive for growth and the labour market than the FOMC has factored in, especially as policy mores from supportive to tight in 2023. This does not mean that the central bank can’t engineer a soft landing, but there is not an immaterial risk of recession given the precedent for policy tightening to kill business cycles.
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown
After many months of scene setting, the curtain has finally gone up and the first dot in the interest rate plot has been followed by the Federal Reserve. The hike of 0.25% was widely expected, given the inflation drama unfolding and it marked the first rise in four years. To show he’s not staying backstage and allowing inflation to run rampant in the stalls Fed Chair, Jay Powell, has signalled this move is the start of tougher action towards rampant prices.
This could also include reducing bond holdings on its balance sheet as soon as May.
The realisation that the stage has been set for a much more aggressive tightening, with possibly six more hikes this year, led to an initial dip in stocks but equity markets largely held onto gains, while bond yields lifted. Overall the sentiment is that given consumer prices are running at the hottest temperature in 40 years, there is scant other direction that can be followed right now.
There are serious worries though that trying to tame surging demand for goods and services by rising the cost of borrowing too rapidly, risks reining in economic growth and potentially tipping the economy into a downturn. Oil has dropped from the shock highs of last week, with Brent crude falling again to below $98 a barrel but the cost of energy, raw materials and components are set to stay hugely volatile due to ongoing supply disruption. The highly uncertain outlook about the knock-on effect of the conflict in Ukraine is clearly concentrating minds, but still trying to bring inflation a bit closer to target for now is top priority.
Focus now moves to policymakers at the Bank of England and their attempt to normalise policy in a far from normal set of circumstances. With waves of Covid still hitting China, conflict raging in Europe and commodity chaos roiling exchanges over the past few weeks, it will be a very tricky tightrope to tread. But a rate rise of at least 0.25% is still firmly on the cards, and given the Fed’s moves and inflation threatening to head higher than 8% in the months to come, we should expect bids around the table to be placed for an even sharper move upwards.
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International
As expected the Fed hiked by 25bp at today’s meeting. However, the main change was a big shift in dot plot where the median dot now shows 7 hikes for 2022. In his comments Chair Powell indicated a consensus in committee to bring back price stability in the economy, including guidance towards starting QT.
We continue to think the Fed will eventually hike 3 or 4 times this year but the ensuing tightening conditions from a very hawkish Fed will damage growth. All in all, given our stagflationary baseline which got exacerbated by the Russia/Ukraine war, it appears that the Fed’s focus will be more on inflation fighting despite the uncertainty created by Ukraine war based on today’s meeting. This creates further headwinds for asset markets as the central bank put remains further out of money in this cycle. From an asset allocation perspective, we remain cautious on both equities and credit markets.
Allison Boxer, US Economist at PIMCO
As was widely expected, the U.S. Federal Reserve raised the fed funds rate by 25 basis points (bps) at its March meeting and strongly signaled more hikes to come given a tight labor market and surging inflation. The Fed also released a new Summary of Economic Projections, which shows large upward revisions to the inflation outlook and a significant corresponding pull-forward of more rate hikes into 2022 and 2023.
The outbreak of war in Europe has made a difficult balancing act even more challenging for Fed policymakers as they weigh an uncertain growth outlook against another jump in inflation. However, the Fed signaled that it thinks inflation risks materially outweigh the downside risks to growth, and as a result we expect the Fed to continue its path toward higher rates and a smaller balance sheet. The Fed would likely need to see significant economic slowing and market dysfunction before shifting from its hiking path, as higher and more broad-based price increases further raise the risk that inflation expectations become unanchored. While elevated inflation risks justify a tighter stance of monetary policy, a faster pace of rate hikes will likely weigh on growth over time as financial conditions tighten more abruptly.
Looking beyond the March meeting, we expect higher inflation and concerns about inflation expectations to continue to weigh more heavily on Fed officials than downside risks to growth in the coming months. As a result, our baseline forecast remains that there will be rate hikes at consecutive Fed meetings and a meaningful further tightening of policy throughout the year. This faster pace of tightening raises the risk of a hard landing further down the road and suggests a higher risk of a recession over the next 2 years.
Gregor Hirt, MA, Global CIO Multi Asset, and Martin Hochstein, Senior Economist, AllianzGI
The US Federal Reserve has raised its benchmark interest rate against a backdrop of high inflation and concerns about the geopolitical situation stemming from events in Ukraine. While markets have previously taken rate-hike cycles in their stride, this time could be different, as the Fed seems to be more hawkish than initially expected. Investors should actively seek out relative-return opportunities.
The Fed had done much to prepare market participants for today’s decision, which explains the relatively muted reaction. Indeed, the evolution of the situation in Ukraine is more important for investors’ short-term risk appetite. The longer it takes to find a negotiated solution, the more uncertainty will persist around potential impacts on global inflation through supply-chain disruptions and rising energy and agricultural prices. This also explains why we continue to have a tactical preference for the US and UK over euro-zone equities, despite more attractive valuation levels for the latter. Investors will continue to favour the relatively “safer” US market in US dollars and the commodity-heavy UK market, while the euro zone’s growth and inflation prospects are more negatively impacted by higher energy prices.
Overall, an environment of moderately higher inflation tends to favour equities over bonds, even though inflation rates over 5%-6% historically penalise the equity market. The bond market is set to remain under pressure as it exhibits some unattractive risk premia, coupled with outflows indicating that investors are starting to question its diversification characteristics. As the Fed continues to raise its leading interest rates while also soon moving to quantitative tightening, we expect a further rise at the long end of the US yield curve. Yields in the euro zone are set to rise, especially once the situation in Ukraine improves, since the European Central Bank is adhering strictly to its key target of maintaining inflation below 2%.
Do opportunities exist in the credit markets where spreads have widened recently? US high-yield bonds look the most promising area as yield differentials with government bonds have become attractive, especially if one expects only “slowflation” and not stagflation in the US. However, the view of our Multi Asset expert group is that it would take a reduction in volatility to spur us to re-enter the asset class – something we do not expect in the coming weeks. The same is true for emerging-market debt. Here, a granular view is vital: some countries will profit from higher energy prices while others could come under tremendous pressure. This is particularly true for countries already made fragile by the Covid-19 pandemic, thanks to the combination of a higher US dollar and spiking import and commodity prices (especially for agriculture goods) – a volatile mix that could lead to civil unrest.
From a style perspective, this is certainly a market in which value – especially quality value – should continue to outperform growth. Historically, value has outperformed in environments of rising inflation, while the actual valuation differential strongly favours value versus growth.
On equities, our Multi Asset expert group maintains our “neutral minus” view in the short term, whereby we expect markets to move sideways with a risk to the downside. We would therefore avoid “buying the dips” for the time being and instead become much more active on a relative basis. In the medium term, we have open questions with regards to the path of equity-market performance. True, markets have typically taken previous rate-hike cycles in their stride. But there have been exceptions, including extended periods when investors were unrewarded for taking market (beta) exposure. We continue to see risks of another such period with broad-based disappointing asset returns
Jason England and Daniel Siluk, Portfolio Managers Janus Henderson
As expected, accelerating inflation forced the hand of the Federal Reserve (Fed) to initiate its first 25 basis point (bps) rate increase of this cycle, thus ending the pandemic-era zero-percent interest rate policy. In our view, high inflation has placed the Fed on a narrow path and increased the risk of policy error, with two potential outcomes – slowing growth and embedded higher inflation expectations – vying for supremacy.
With our expectation that U.S. monetary policy will ultimately prove to be more dovish than many expect, we believe longer-dated bonds remain at risk to continuing inflationary pressure.
In a well-telegraphed move, the Federal Reserve (Fed) raised its benchmark overnight policy rate by 25 basis points (bps) on Wednesday to a range of 0.25% to 0.50%. Perhaps more importantly, the U.S. central bank’s own forecast for the future path of rate hikes – as expressed in its “Dots” survey, which records each Fed official’s projection for the federal funds rate – increased to seven hikes for this year and four for 2023. In the December survey, these expectations were for three hikes in each of these years.
While some may interpret this as a continuation in the shift toward a hawkish bias, we are more circumspect. We believe that the seven 25 bps rate increases the futures market is pricing in for this year very much represent an upper limit of potential hikes and that this scenario is unlikely to materialize. Also, the current Dots survey comes with a considerable caveat: There were fewer voting members at this week’s meeting due to the ongoing transition in the Fed’s leadership composition and none of President Biden’s nominees have taken their seat. Importantly, we believe that eventual new members will lean toward the dovish camp, reinforcing our view that the market’s expectations have gotten ahead of reality. It’s worth recalling that throughout Chairman Jerome Powell’s tenure, when given the choice between two paths – and having not been mugged by multi-decade highs in inflation – he’s opted for greater accommodation.