Vijay Kumar Gaba

The US Federal Reserve Open Market Committee (FOMC) decided to hike the key federal fund rate by 25bps to 4.75% - 5% range. This is the eighth straight hike decision by the FOMC since the Fed started its fight against inflation in March 2022; bringing the rates to highest since September 2007.

Speaking to the press post FOMC meeting, the Fed chairman Jerome Powell, dismissed the speculation about any imminent rate cuts, stating “FOMC participants don't see rate cuts this year, it is not our baseline expectations”.

The post meeting statement of FOMC indicated that the policy may remain sufficiently restrictive though future hikes shall be data dependent. The statement read “The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time” and “The Committee will closely monitor incoming information and assess the implications for monetary policy”.

The market participants interpreted the statement to imply that at least one more rate hike of 25bps will be done this year, before the Fed hits a pause button.

Powell emphasized that the Fed is “committed to restoring price stability, and all of the evidence says that the public has confidence that we will do so.” Speaking about the recent banking sector crisis, the chairman assured that “US banking system is sound and resilient” and the Fed is “prepared to use all of its tools to maintain stability.” He however admitted that recent banking turmoil is “likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes.”

The Fed maintained that the current pace of quantitative tightening (QT) shall continue, though recent emergency measures to mitigate the impact of the banking crisis have resulted in expansion of its balance sheet.

The US equities ended the session with a cut of 1.6%; while US dollar index 9DXY) lost 0.7%.

 “Higher interest rates, slower growth and a softening labor market are all painful for the public that we serve, but they’re not as painful as failing to restore price stability and having to come back and do it down the road again.” – Jerome Powell, Chairman of the US Federal Reserve

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) decided to hike the policy rate by another 75bps taking the federal fund rate to 3.0%-3.25% range; the highest level since 2008.

In the post meeting press statement, the Fed chairman Jerome Powell reiterated Fed’s commitment to bring down the inflation to its target level of 2%. The Fed officials indicated that the Fed would keep hiking rates further till the terminal rate of 4.6% is reached next year. This implies another possible 75bps hike in November, followed by a couple of smaller hikes in the two subsequent meetings. Quelling the market expectations of a cut next year, the fed officials hinted that no cut is seen in 2023.

Six of the nineteen FOMC members even see the terminal rates at 4.75%-5%, implying a 175bps further hike till 2023 end, before the Fed begins to scale down in 2024, bringing the rates back to below 3% only in 2025.

It is pertinent to note that there is no precedence of Fed hiking so aggressively since 1990 when the overnight funds rate was adopted as its primary policy tool. In 1994, Fed had hiked 2.25%, resorting to cuts the very next year. US Inflation had probably peaked at 9.1% ( CPI, yoy) in June, before easing to 8.3% in August.

Indicating a recession-like condition in 2023, in their quarterly estimate of rate and economic outlook, FOMC stated that unemployment rate may rise sharply to 4.4% in 2023 from the present 3.7%. FOMC scaled down its estimates for economic growth in 2023 to 1.2% and 1.7% in 2024, reflecting a bigger impact from tighter monetary policy.

From this month, the Fed has also accelerated its quantitative tightening program with US$95bn/month reduction in its US$8.9trn balance sheet.

The Fed decision did not bring any surprise for the market, as the consensus was for a 75bps hike, with a minority expecting even a 100bps hike.

·         The US benchmark indices ended the day with sharp cuts after a highly volatile session.

·         USD Index (DXY) strengthened to over 111, its highest level since April 2002.

·         Industrial metals and crude ended with over 1% cut, while Silver (2.2%) and Gold (0.6%) were higher. Bitcoin lost over 2%.

·         Bond markets quickly priced in the growing risk of a recession as the Treasury yield curve further inverted. The 2-year treasury yield over 10-year Treasury yield inverted to beyond 50-basis points.

Indian markets are also expected to open with a cut of about 1%.

In its latest meeting the US Federal Reserve Open Market Committee (FOMC) reiterated its position stated in the last meeting. The Committee maintained status quo on the Fed rate (Repo Rate) and its asset (bond) buying program (US$120bn/month). The limit for single counterparty under reverse repo has been raised to US$160bn from the present US$80bn, allowing the banks to park more money with the Federal Reserve.

The Committee reiterated its stance of last meeting, stating that “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted”; implying that the FOMC decision on QE continues to be data driven, and the present reading of data guides a gradual unwinding of the monetary stimulus introduced to mitigate the impact of Covid-19 pandemic.

“While no decisions were made, participants generally viewed that so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate”, the Fed Chairman said in a post meeting conference.

The Chairman also informed that the Committee feels that the Fed is closer to passing the test of “substantial further progress” on employment and inflation. Accordingly, more members now see the first rate hike happening in 2022. It is pertinent to note that in June, when FOMC members last released their economic projections, a slight majority of members had projected rate increase into 2023.

The markets have obviously read what it wanted to in the Fed statement. The bullish response to the Fed statement implies that market is giving more credence to the “slower growth” forecast than the “higher inflation” expectation. The market move post Fed statement implies that the confidence in “November Taper” is much lower given the slowing growth and uncertainties in Chinese markets. Even if the tapering begins in November, the pace may slower than anticipated. Also, the data for the “lift” (rate hike) may not adequate as of now and much more evidence may be required before a concrete lift decision could be taken.

Despite the headline inflation running much higher than the fed target of 2%, FOMC did not appear concerned about price situation. The Chairman repeatedly stressed in his interaction with the press that “he expects price pressures to subside as supply chain factors, goods shortages and unusually high levels of demand return to pre-pandemic levels’; thus reiterating his “transitory” stance on inflation.

Many analysts have related the Fed decision to postpone the question of Tapering to the November meeting, to the debt ceiling fracas in US. “The Fed never makes major changes to policy when there are major unresolved issues in Washington,” said Danielle DiMartino Booth, chief executive of Quill Intelligence. “Between the debt ceiling, budget resolution and potential for a government shutdown, there are plenty of political reasons for the Fed to not change policy.”

In my view, Fed would refrain from taking any decision till the (i) concerns over Covid-19 variants subside materially; (ii) political fracas in US ends amicably; (iii) dust created by Evergrande settles down and (iv) “transitory” nature of inflation is denied. November Taper, if at all happens, would be slow (may be US$10bn/month) and protracted. The rate hike decision is still in the realm of speculation.