Vijay Kumar Gaba

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) unanimously decided to hike the key bank rate by 50bps to 4.25%-4.5% target range, the highest since 2007. From near zero in the beginning of the year, this is perhaps the sharpest rise in rates in one calendar year.

In the customary post meeting press conference, the Fed chairman Jerome Powell emphasized on the commitment to rein inflation. He said, “we still have some ways to go” and “I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way,” indicating that rates will rise in 2023, though not at the same speed as 2022. The Fed chairman reiterated, “It is our judgment today that we are not at a sufficiently restrictive policy stance yet,” adding “We will stay the course until the job is done.”

The Fed Chairman had stated after the November FOMC meeting that the pace of tightening is less significant than the peak and the duration of rates at a high level. The Fed’s latest stance also emphasizes that the markets should brace for “higher for longer”.

The FOMC statement clearly indicated that they are aware that higher rates will impact the economy adversely. The projected unemployment rate for 2023 has been hiked to 4.6% from 3.7% in November 2022, as the economy is forecasted to grow at just 0.5% in 2023, at the same pace as 2022. The Chairman noted, “I wish there were completely painless way to restore price stability. There isn't, and this is the best we can do.”

It would be interesting to see if the Fed can actually deliver a soft landing of the economy as promised, without triggering a deeper recession, while attaining a milder inflation as per the target.

The Fed Chairman welcomed the recent lower inflation prints, but wants more substantial evidence to believe that the inflation is on a sustained downward path. He said, “the inflation data received so far in October and November show a welcome reduction in the pace of price increases, but it will take substantially more evidence to give confidence inflation is on a sustained downward path.” The Fed now expects the personal consumption expenditures price index, currently running at 6% - to cool to 3.1% in the final quarter of next year and to 2.5% by the end of 2024.

Belying the market expectations, the Fed Chairman clearly hinted that the rate hikes will continue in 2023 and the policymakers projected rates now indicate that we may end the next year around 5.1%, slightly higher than the previous projections. The dot plot now indicates a cut of 100bps from 5.1% in 2024.

 The latest policy statement and the aggressive stance of the Fed, is likely to anchor the inflationary expectations while resting the frequent speculations of an imminent “peak” followed by immediate easing of rates.

The equity markets were disappointed as most participants were expecting a “peak” below5% and a cut in 2023 itself. The stock ended lower after a volatile session. The bond markets were however not too bothered and yields ended marginally lower after the Fed statement.

 About a quarter of a century ago, I had just joined a midsized investment banking firm. My team of three people was assigned a mandate for IPO of a real estate company. We worked very hard (of course on our Excel Sheets and without the help of Saint Google) on the mandate and prepared a proposal which suggested that IPO may be priced in the band of Rs12-15. After the initial presentations were made, the team went to the promoter with the promoter of our firm for final presentation. After a detailed slide show was made, our boss told us to excuse them for 10minutes. After 10minutes, our boss came out and instructed, “IPO is in Rs28-30 band, prepare to file the documents for approvals.”

This being my first experience, for a moment I was in a position of shock. I found the pricing ridiculous. I even told my senior that this IPO cannot be sold at this price. My senior who had experienced many such situations before just smiled and told me to shut my mouth and get on the job. Eventually, the IPO was a success and the stock went on to become a compounder for the shareholders.

After reading and listening the expert commentators on various media platforms about the decision of the US Federal Reserve last night, I am getting a strong feeling of déjà vu. Millions of “experts” like me advised the FOMC about what they should be doing in the meeting and what the Chairman Powell should be saying after the meeting. But they have done and said what is most expedient for everyone – markets, government, economy and bankers. The novice may cry foul, but experienced ones know how does it work.

“Dot Plot” is a new buzz word that Indian electronic media has decided to learn. There are zillions of experts who are discussing the dot plot on social media platforms in India. It is heartening to note that we have become buzz word compliant.

“Dot plot” is a simple form of data visualization that consists of data points plotted as dots on a graph with an x- and y-axis. These types of charts are used to graphically depict certain data trends or groupings. US Federal Reserve uses this tool to present how the members of the Federal Reserve Open Market Committee (FOMC) perceive the benchmark bank rate over next few years.

The market experts discuss this “Dot Plot” intensively after every FOMC meeting. There is however little evidence to indicate that the actual trajectory of Fed benchmark rates has followed the dot plot. There is also little correlation between the actual trading positions and dot plot beyond 2days before and after the dot plot.

I like to compare the dot plot with the exit polls of elections in India. These are discussed intensively. They impact the market for two days (between exit polls and actual results). But there is little evidence to suggest that exit polls have a strong correlation with the actual election results; or any political strategy is formed on the basis of the results of exit polls..

The latest dot plot indicates that 13 of the 18 FOMC members believe that there will two rate hikes (from present 0-0.25%) in 2023, i.e., two years from now. 7 of the 18 FOMC believe that rate hike may actually happen in 2022.

I see there are many traders who want to trade on the basis of this dot plot. For all these enthusiast, my suggestions are as follows—

(i)    It is good to be buzz word compliant, but placing trade on these buzz words is not good idea.

(ii)   The actual decision to hike rates is always dependent on real economic data, not perception. Usually the hikes are after the economic activity has picked materially, output gap has shrunk and inflation has started become threatening. A rate hike under such circumstances is healthy.

(iii)  There is strong evidence to indicate that markets have usually done very well after healthy rate hikes.

For the record, FOMC has indicated that the US economic activity is recovering strongly. However, there is not enough evidence to warrant a rate hike in next 12months. A strong US economic recovery is good for global economy and markets; and continuing low rates and comfortable liquidity for next one year should continue to support the risk trade. Rest all is the TV discussion on exit polls.