On 27 July, the Federal Reservse enacted its second 75bps rate rise in as many months as it doubled down on its commitment to fight back soaring inflation. This move was unanimously supported by Fed policymakers and widely expected by the market. Though seen as bold – before June, the last time the Fed had raised rates by 75bps was in 1994 – many commentators expect this to be the highest the central bank will go for the time being.
One of these is Insight Investment portfolio manager Scott Ruesterholz, who regards the current situation as “peak hawkishness” being reached by the Fed.
“We think the hiking path will be slower from here, although we disagree with market pricing that suggests rate cuts as soon as next year,” says Ruesterholz. “While we almost assuredly have not seen the peak in rates, we have potentially seen peak hawkishness.”
Action from the Fed was expected following recent inflation data, and GDP shrinking by 0.9%, technically pushing the US into recession. The consensus forecast had been for 0.5% growth.
“While inflation is currently running at the highest level in 40 years, there have been tentative signs that a combination of decreasing supply pressures and demand has caused inflation to peak,” says Dan Boardman-Weston, CEO and CIO at BRI Wealth Management. “The Fed has a difficult balancing act though as the current inflationary pressures require higher levels of interest rates, but the slowing economy could really do with a more accommodative stance.”
Reading between the lines
Talk of peak hawkishness and dovish turns are largely due to analysis around the rhetoric accompanying the rate hike itself.
From Draghi’s “whatever it takes” pledge, to Bernanke’s taper omission, post-crisis markets have become increasingly focused on the language of central bankers. The Fed’s July announcement was no different and PGIM chief investment strategist, fixed income, Robert Tipp pointed to a “nuanced tone” from Fed chair Jerome Powell.
“While [the Fed] emphasised continued vigilance in fighting inflation, it acknowledged the slowdown in certain economic segments,” says Tipp. “Powell indicated that, from here, the Fed will be making decisions on a meeting-by-meeting basis.
“Given the confluence of more mixed economic data and expectations that lower energy prices will at least help moderate headline inflation in July’s CPI reading, we anticipate the Fed’s pace of rate hikes will likely slow down a bit from here.”
The Federal Open Market Committee (FOMC) will next reconvene on 20 September, but the important Jackson Hole seminar is due to take place before then, between 20-27 August. Until then Thomas Costerg, senior US economist at Pictet Wealth Management, points to recent strong labour market data as giving the FOMC valuable waiting time.
“Regarding the next meeting in September, if the signal is pointing to a drop in the rate and in particular a move from 75bp to 50bp, we think that the drop could be more pronounced with only +25bp given the upcoming deterioration of the economic data,” says Costerg. “The Jackson Hole seminar at the end of August will be the final test. We could feel that Powell did not want to say too much this time, sensing that this important deadline was coming up.”
Where 2022 could end
High inflationary impacts are being seen around the world, with the European Central Bank recently forced to raise interest rates by 50bps, when projections had been for half as much after lagging its hike happy peers over the past year. On Thursday, the market will find out if the Bank of England will continue its rate rising record of back-to-back increases since December 2021.
The ECB is finally out of negative territory and the BoE could hit 2% this week.
The Fed’s actions were expected and Jason Simpson, fixed income strategist at SPDR, says this has relieved some pressure on other central banks that can also now ‘wait and see’ what the data does.
“However, it is a reaction to the conundrum faced by most policymakers of trying to bear down on inflation in the teeth of a growth slowdown,” adds Simpson. “Market pricing for the September FOMC is a more moderate 50bp which has seen the US$ slip and should help the world outside the US, especially emerging markets.”
All eyes will still be on what news comes out of Wyoming after the crucial meeting in August with data likely to be closely monitored in the runup. Albemarle Street Partners CIO Fahad Hassan explains: “The Fed will have eight weeks of data at their disposal when they meet again in September. Having reached neutral, the Fed is likely to slow its pace of policy tightening if, as anticipated, inflation begins to decline in response to a slowing economy.”
Labour statistics, growth data, and inflationary signs will all be under the microscope, but De Lisle Partners co-founder Richard de Lisle says currency movements will be key.
“Since the [rate hike], the statement has caused the trade-weighted dollar index to weaken 1% and bonds are slightly up,” says de Lisle, who manages the VT De Lisle America Fund. “The euro has held above parity and sterling has held above $1.20. The other central banks will be relieved by the statement: finally, the Fed acknowledges the mighty American economy weakens. They will be able to do nothing. For now.”
In agreement is Charles Stanley chief investment commentator Garry White who says the Fed is unlikely to change policy at other central banks – instead the dollar will capture markets’ attention.
“A strong greenback upends everything from the cost of imports to the profitability of multinational companies,” says White. “The most significant impact of a potentially less aggressive Fed is not on the policy of other central banks directly, but in currency markets. If the dollar weakens, governments, central bankers, and corporations all around the world will be relieved.”