By Ritika Chhabra
The Federal Reserve hiked the Fed fund rate by 75bps yesterday, in line with the market expectations. Counting in the latest hike, the policy rate is now set to a range of 2.25% to 2.5%. This is the first back-to-back 75bps rate hike in the US since the 1980’s. However, what cheered the markets were Jerome Powell’s comments in his press conference. Investors were hoping for some dovish comments from the Fed chief after aggressive back to back rate hikes and they sure got what they hoped for. Powell mentioned that with the current rate hike, much of the front loading of the hiking cycle is achieved and the current interest rate levels are in line with ‘neutral’ interest rate. The ‘neutral’ rate means a rate which is neither too accommodative, nor too restrictive for the economy, thus implying that the Fed thinks it is no longer behind the curve.
Powell also allayed investors’ fear of further aggressive rate hikes pushing the US economy into recession by saying that further hikes will be purely data dependent and the Fed will slow the pace of rate increases at some point to assess the impact of higher rates on economy and inflation. This is exactly what markets wanted to hear and risk assets rallied with the S&P 500 rising by 2.6% and Nasdaq 100 jumping over 4%. For now, future markets for federal funds are expecting a 50bps hike with a probability of 72% (up from 40% a week ago) and 75bps with a probability of 28% (down from 47% a week ago). For subsequent meetings in Nov and Dec, rate traders are expecting 25bps of rate increase in each meeting, which will push the year end rate in the range of 3.25% -3.50%. This is lesser than the 3.8% that markets were expecting earlier for the year end.
That said, markets might not like any negative surprises going forward as the investors are currently pricing in ‘no-more hawkish’ Fed. While the inflation may have peaked due to the recent fall in commodity prices, it is still far away from the Fed’s target rate of 2%.The core inflation remains sticky, thanks to strong labor market and unemployment levels close to record lows. History shows that controlling persistent high inflation is rarely possible with the labor market running hot. And given a choice between inflation and growth, the Fed would most likely take the risk of a hard-landing outcome than allowing inflation to remain above target levels for too long. At some point, we will have to face either higher rate increases and slower economic growth or persistent inflation for a longer time (if Fed pivots too early). Till then, we will enjoy this rally in risk assets which has left everyone guessing if it’s a bear market rally or start of a new bull market.
(The author Ritika Chhabra is an Economic and Quant Analyst at Prabhudas Lilladher. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)