Trading Signals 05/02 – 09/02
The Fed’s Rate Is At Its Maximum: What’s Next?
In just under a year and a half, the U.S. Federal Reserve System has raised the fundamental interest rate by 0.25 percentage points, reaching a range of 5.25-5.5%. This amounts to an increase that is eleven times greater than before. The regulatory body overseeing financial matters hasn’t definitively indicated whether this will be the last instance of raising the rate within this cycle, allowing for flexibility in the upcoming September meeting. Are we witnessing the final interest rate hike, and what sort of repercussions might it have on the financial markets?
The break in the U.S. Federal Reserve’s efforts to make monetary policy more stringent didn’t last long. On July 26th, the American financial overseer once again increased the fundamental interest rate by 0.25 percentage points, bringing it to a range of 5.25-5.5%. This marks the highest rate level in the past 22 years.
However, the uncertainty about where the U.S. interest rate is headed next remains. The forecast made by members of the regulatory body in June suggested that there would be at least two more increases in the rate this year. During the press conference held on July 26th, Federal Reserve Chair Jerome Powell mentioned that decisions in upcoming meetings will be made gradually, considering the information coming in from one meeting to the next. Powell stated, “Of course, it’s possible that we might raise rates again at the September meeting if the relevant data supports that direction. But it’s also a possibility that we could announce a pause.”
Bloomberg has pointed out that Jerome Powell’s language on tackling inflation has seen little change compared to the previous meeting. He reiterated that the Federal Reserve will need to keep interest rates relatively high for a while to combat rising inflation. This strategy might involve a period of economic growth that’s below average and some weakening in the job market, according to Powell.
Powell also mentioned that the U.S. economy is experiencing growth at a moderate pace, which is a slight shift from the wording used in the June meeting, where he referred to “modest paces” of growth. He also indicated that the Fed’s economists are no longer forecasting a recession in 2023, given the recent stability of the economy. However, they do anticipate a noticeable slowdown in growth starting towards the end of this year.
Anna Wong, the Chief U.S. Economist at Bloomberg Economics, noted that while most Federal Reserve officials maintain a fairly cautious stance, Powell’s language seemed somewhat milder during the press conference following the meeting. Wong predicts that this softened tone from the Fed chair implies a readiness to skip a rate hike in the September meeting if inflation data remains positive.
The Fed Is At A Crossroads
The fact that inflation is lower than anticipated adds weight to the possibility that the July meeting might have marked the conclusion of the series of measures to tighten monetary policy. In June, the core consumer price index, which excludes the volatile prices of food and energy, only increased by 0.2%, the smallest rise in over two years. In the yearly perspective, the growth of this index slowed down from 5.33% to 4.8%.
However, Christopher Waller, a member of the U.S. Federal Reserve Board, stressed that before declaring victory over inflation, substantial evidence is needed to confirm that the recent deceleration wasn’t merely a random occurrence. “While the recent report is encouraging, we need to carefully consider the situation before making a final decision. Relying on data from just one month is insufficient,” he commented.
Experts and analysts are divided on the Federal Reserve’s future actions. Some believe that the cautious approach will continue in September due to recent softer inflation data. They point out that the Federal Reserve is likely to be mindful of not making the mistakes of the past when they tightened too early. On the other hand, there’s a perspective that given the recent data suggesting a smoother economic transition, the Federal Reserve might not want to disrupt the current stability. This could lead to a pause in September that might extend further.
Another view suggests that despite a strong labor market and a gradual slowing down of core inflation, the rate increase in July might signify the end of the current cycle. The rationale here is that the current interest rates are already quite high and capable of managing inflation and economic activity. Pushing for further rate increases could pose risks, particularly for the banking sector and industries like real estate.
Market expectations, reflected in futures data, lean towards the idea that the July rate hike could be the final one in the current series of increases.
Recent data is indicating that the U.S. economy can handle increases in interest rates, according to an expert in macroeconomic analysis. For example, consumer confidence reached a two-year high in July, exceeding market expectations. Additionally, housing prices in major U.S. cities have been on the rise for the past few months, consistently increasing by a noticeable margin.
However, there’s a growing concern about future predictions, particularly for the upcoming year. An economic indicator that forecasts economic trends has been decreasing for the last 15 months, which is the longest consistent decrease since the pre-Great Recession period of 2007-2008. This puts the Federal Reserve in a challenging position. On one hand, they need to avoid prematurely easing monetary policy, which could lead to prolonged high inflation. On the other hand, they must be cautious not to slow down the economy by maintaining high interest rates. It’s a delicate balance that requires careful consideration.
The market’s response to the recent 25 basis points rate increase appeared relatively minor, given that this adjustment had already been factored in. Bullish investors have been propelling the market upwards over the past weeks, speculating that this rate increase in July could mark the end of the ongoing cycle for the Federal Reserve. Since the preceding Fed meeting in mid-June, the broader S&P 500 index has recorded an almost 5% increase, before correcting to 4340 on the back of the strengthening of the dollar after promising news on inflation.
In the immediate term, market dynamics will likely be shaped by elements beyond the Federal Reserve’s communications, including the release of quarterly earnings reports and fresh macroeconomic data, as suggested by experts.
Following the meeting, the U.S. dollar index, which measures the dollar against a basket of major currencies, witnessed a decrease of 0.6%, potentially due to the relatively cautious stance conveyed by multiple experts. The dollar index has encountered an approximate 4% drop since the onset of June. However, after the data on inflation of 3.2% year-on-year, it has regained losses and is currently at around 103.280.
Compared to other central banks globally, the United States seems to be edging towards the conclusion of its rate-hike cycle. The Federal Reserve’s more accommodative approach could exert downward pressure on the dollar over the medium term, as outlined by senior economists.
The impact of the Federal Reserve’s rate decision on commodity markets remained somewhat limited. Similar to the stock market, the anticipation of the 25 basis points rate hike had already been factored into commodity prices. A more substantial influence on commodity markets could potentially stem from the actions of other central banks. If these banks opt to raise rates while maintaining a firm stance, it’s plausible that the price of gold might exceed a specific threshold, as projected by various analysts.