Markets
Lift-off. We have a lift-off. The Fed hiked its policy rate yesterday by 25 bps to 0.25%-0.50% in a near unanimous vote. St.-Louis Fed Bullard dissented in favour of a 50 bps rate hike. Such move could well be the case later this year. Updated policy rate projections by individual Fed governors show that 7 out of 16 governors want to implement more tightening than the equivalent of an additional 25 bps at the six remaining policy meeting. The latter is this year’s median projections (1.75%-2% policy rate band by end 2022) with only 4 governors suggesting to go slower. The Fed expects its bold and brave tightening cycle to end next year. The median policy rate projections for both 2023 and 2024 stands at 2.75%. For the first time, Fed governors this way indicate willingness to lift the policy rate above their projected neutral rate (2.4%) into slightly restrictive area. The individual headcount shows willingness to do so by 11 out of 16 governors. US money markets align with the Fed for this year, but currently believe that the tightening cycle will end near neutral rates in 2023, discounting already a policy rate cut in 2024.
It’s quite striking that 2023 and 2024 PCE inflation (both headline and core) forecasts remain above the Fed’s 2% inflation target despite this rather aggressive policy stance. The unemployment rate is also forecast to stabilize in these conditions around 3.5%, below the NAIRU (4%). The combination of forecasts implies the best case scenario of a very smooth landing with Fed Chair Powell on multiple occasions downplaying recession risks. Growth is expect to run slightly above 2% in 2023 and 2024.
In our view, the inflation and unemployment forecasts mainly imply upside risks to the Fed’s policy rate projections. Powell backed the Fed’s policy turn at the Q&A session with the press. The Committee is determined to use all tools available to return the economy to price stability.
The US economy is very strong and well positioned to handle tighter monetary policy. It’s clear to everyone that multidecade high inflation needs a reaction especially given the very, very tight labour market. “Tight to an unhealthy level”, Powell said. The Fed dedicated an additional paragraph in its opening statement to the Russian invasion in Ukraine. The impact on the US economy is uncertain but upside inflation and downside economic risks arise. With the gently 25 bps rate hike, Fed Chair Powell yesterday stuck to his promise not to become an additional factor of market stress. In the same vein, the Fed refrained from giving guidance on the future balance sheet run-off. Plans are being finalized and will be made public at the May 4 policy meeting. The actual shrinking will start soon after.
The market initially reacted as could be expected: US Treasuries fell with the front end underperforming, the dollar profited and stocks ceded ground. However, moves partly reversed during the Q&A session as Powell’s message was more in line with (hawkish) expectations.
The US yield curve flattened with yield changes ranging between -2.5 bps (30-yr) and +9.3 bps (3-yr). EUR/USD closed above 1.10, recovering from an intraday low around 1.0950. US stock markets eventually closed 1.5% (Dow) to 3.75% (Nasdaq) higher. Going forward, this Fed meeting strengthens the sell-off on bond markets and suggests that the ECB’s March policy shift gives the EUR significant backing. We remain unconvinced about stocks’ rebound momentum.
News Headlines
Australia’s labour market remains in excellent shape, adding 77.4k jobs in February. That’s more than double the 37k expected and follows an upwardly revised January (28.3k). Hours worked soared 8.9% m/m after a steep omicron-driven decline in January. Strong employment allowed the unemployment rate to nudge lower to 4%, matching the pre-GFC lows. The decline came even as the participation rate rose to a record high of 66.4%. The labour market is extremely tight and ups the pressure on the RBA to start raising policy rates. The central bank for now says it stays patient and needs more evidence of inflation sustainably hitting target. Money markets meanwhile price in five rate hikes this year with the lift-off occurring in July. The Australian dollar rises above AUD/USD 0.73 this morning. In other news Down Under, New Zealand GDP in 2021Q4 expanded 3% q/q, recovering from the -3.6% in Q3 and to be 3.1% higher y/y. NZD/USD holds on to yesterday’s gains around 0.6840.
