As was largely expected, the US Fed increased its policy rate in the November 2 FOMC meeting. The earlier range for the federal funds rate was 3.00-3.25, while the rates were hiked by 75 basis points to settle at the range of 3.75–4%. “Federal reserve delivered 75 bps rate hike on expected lines and maintained its position of inflation control as a top priority. The market was expecting a bit dovish tone from the Federal Reserve, but the federal reserve did not provide any such indication. However, the federal reserve’s tone was not hawkish either. We now anticipate that federal reserve might not deliver 75 bps moves going ahead, however, pivot might shift to 5% instead of 4.5%-5%,” says Akhil Mittal, senior fund manager, Tata Mutual Fund.
Even though the quantum of the rate hike was expected, the stock market tanked. The S&P 500 reversed from around 3,900, and briefly tried to bounce around 3,800, but ended on session lows down 2.5% at about 3,760, closing just above its 20d moving average (3,730).
The growth stocks were hit the hardest with the NSYE FANG+ index closing down more than 3.5% hitting a new YTD low. The US Stocks closing the day’s session in red shows that the Fed is not close to ending the rate hike cycle. Dow Jones Index closed lower by 1.55% while Nasdaq Composite closed lower by 3.36%.
Of the many reasons for the market to fall, one could be the surprise element in the Fed Chief’s commentary. Michael Reinking, Sr. Market Strategist, NYSE says, “As expected, the FOMC raised rates by 75bps but there was a bit of a surprise within the statement. The forward guidance language changed from “ongoing increases…will be appropriate” to include the following qualifiers: “to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.
The Fed Governor also outlined the risks of an early pause in rate hikes. According to the policy statement, ongoing target range increases will be necessary to achieve a stance of monetary policy that is sufficiently restrictive to bring inflation back to 2 percent over time. These were the signals to the market that there could be more pain ahead and as a result, US stocks closed down lower.
In the press conference following the policy announcement, Powell stated that considering a pause is premature and that given the incoming data, monetary policy will need to be “sufficiently restrictive” and that the terminal rate is likely to be higher than initially anticipated. Additionally, Powell emphasized that premature pauses carry greater dangers than excessive interest rate increases, reinforcing the Fed’s hawkish position.
The Fed may not let its guard down on inflation just yet, but this 75-bps rate increase may be the last one they have made. In December, the US Fed is expected to issue a 50 basis point increase, and this cycle’s terminal policy rate will be at or just above 5%. “While the Fed seemed to allude to the quantum of future rate hikes being lower than 75 bps, Powell reiterated that there still a lot of work to be done in the fight against persistent inflation. So, there is still no clear visibility on the terminal rate yet,” says Atanuu Agarrwal, Co-founder, Upside AI.
The core inflation is still untamed and the economic growth is posing problems for the Fed. “Despite previous hikes, the U.S. economy has returned to economic growth, as shown by the latest GDP data (2.6 percent for the third quarter). In addition, job creation in the U.S. economy appears to be maintaining its post-pandemic pace, which may also convince the Fed to continue tightening monetary policy. The Fed may still believe that inflationary risks are directed more upward, and that continued rate hikes are appropriate and that a sustained period of below-trend growth is required to bring inflation under control,” says Daniel Kostecki, a senior market analyst, Conotoxia, an investment company.
Expectations of any indications of a Fed turnaround in terms of future guidance were dashed. However, the terminal rate is likely to be higher than initially anticipated. The central bank hinted that it would slow the pace of rate hikes, possibly as early as December.
The Federal Reserve described a probable change in its approach to future monetary policy actions in the policy statement, taking cumulative tightening and policy rate hike lags into account. Jerome Powell, the chair of the Federal Reserve, added that it might be better to reduce the rate of rate increases as soon as the next meeting or the one after that.
“The federal reserve acknowledged that the future rate uptick will take into account cumulative rate hikes so far, the lags with which monetary policy affects economic activity and inflation as well as economic and financial developments,” says Kunal Valia, Chief Investment Officer – Listed Investments, Waterfield Advisors.