After increasing 225 basis points in 2022, the US Federal Reserve has a clear task at hand. Inflation needs to be tamed for which a series of rate hikes are on the cards. Indranil Pan – Chief Economist, YES Bank in a report titled ‘FOMC: A dovish hike’ takes you through the possible Fed action from here on.
As anticipated, Federal Open Market Committee (FOMC) hiked the policy rate by 75 bps for a second consecutive time to 2.25-2.50%.
Fed Chair Powell did not provide any material forward guidance but signaled for a data-dependent Fed going forward. He guided to the fact that the current dot plot projections of a 3.25-3.50% FFR by December 2022 remain appropriate, thereby indicating an increase of 100 bps from the current levels.
This probably signals a slowing of the pace of rate hikes.
While the Fed is aware of the slowing effect on the economy, the recession is not something on their minds now as the labour markets continue to stay strong.
The currency market rejoiced on the dovish rate hike. The dovish hike also led to a relief rally for risk assets though the recession likely will have to be soon priced in.
With 225 bps of a rate increase in the current interest rate cycle so far, the Fed remains concerned about inflation with Powell indicating that the outsized rate increases in the last couple of meetings were to account for the upward surprises in the inflation prints, including that in June, at 9.1% YoY.
While Powell acknowledged slowing growth, the risks of a full-blown recession were thought unlikely as labor market continues to remain right.
Even as Fed’s ‘Global Supply Chain Pressure Index’ appears easing, the concern for US inflation comes from higher food prices. Note that food prices find mentioned in the policy statement apart from the usual causes of inflation including higher energy prices, supply chain disruptions etc.
As forward guidance, Powell indicated a more moderate pace of increase in the meetings ahead, even as he did not shut out the chances of another 75 bps rise.
On the other hand, it was pointed out that the federal funds rate (FFR) is already in the “neutral” zone and that further increases remain essential to push it to the restrictive zone and thus enable depressing demand below trend to bring down inflation.