By Michael O’Neill
The screeching sound you heard wasn’t your favourite opera diva getting ready for a show, it was financial markets reacting to the Fed’s monetary policy statement and Chair Powell’s press conference.
The Federal Open Market Committee (FOMC) raised its overnight rate by 25 bps, to 4.75%, and traders interpreted as a “dovish hike.”
Mr Powell attempted to convince a sceptical audience that slowing the pace of interest rate hikes to 25 bps from the 50 bps in December wasn’t a declaration of victory.
He started his press conference reminding markets that more rate hikes are likely due to current inflation levels.
He said that the reduction in inflation over the past three months shows a welcome drop, but the Fed needs substantially more evidence to be confident that inflation is on a sustained downward path, adding we have more work to do.”
He reiterated, “We continue to anticipate that ongoing increases in the target range for the federal funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”
So, inflation is down but not nearly enough to stop raising interest rates and that implies another 25 bp rate bump is likely on March 22.
If that wasn’t clear enough, Mr Powell said “Given our outlook, I don’t see us cutting rates this year, if our outlook comes true.”
The statement and Powell’s comments are not dovish-far from it, but they were not what the market wanted to hear.
Traders decided that a 25 bp rate hike was the Fed’s opaque way of signalling that interest rates were not just very close to peaking, but that they would be reduced before year end. The CME FedWatch Tool is pricing in a 60% chance that rates will be 4.5% by December.
Those believing that the Fed rate hike cycle would end sooner than expected were empowered when Mr Powell responded to a question from CNBC reporter Steve Liesman saying it is “certainly possible” that the benchmark rate would stay below 5.0%.
Powell reinforced that view when he said, “We can now say I think for the first time the disinflationary process has started.”
The old adage of “don’t fight the Fed,” seems to have gone the way of the rotary dial phone.
Many financial market participants seem to have lost respect for the institution. The Janet Yellen/Jerome Powell led Fed’s have grossly misread the economy, specifically the post-pandemic spike in inflation at the same time senior Fed officials were busy being “insider traders” rather than stewards of the economy.
The post-meeting market reaction is traders telling the FOMC “we don’t believe you.”
That explains why the S&P 500 index soared 2.8%, peak to trough before closing with a 1.05% gain. Bond traders voted with their wallets and knocked the US 10-year Treasury yield down from3.52% to 3.39%, while US dollar bears devoured dollar bulls in a feeding frenzy to rival anything seen on Shark Week.
Source: Discovery Channel
The fall-out from today’s FOMC meeting should be taken with a grain of salt, or perhaps an entire shaker full.
When did the risk of the Fed raising rates in 25 bp increments become a dovish scenario? It’s not.
The Fed has raised or lowered rates 67 times since March 21, 2000, and Feb 1,2023, with 25 bp changes occurring 63% of the time. Arguably 50 bps are not normal moves having happened just 17 times, while 75bp (6 times) and 100 bp changes (twice) are relatively rare.
More than likely, the latest 25 bp rate hike is not a signal of any kind but just a less aggressive defence against rising inflation.
Those believing inflation has been beaten and that the door is wide open to lower interest rates are ignoring geopolitics.
The Russian war against Ukraine is at risk of escalating further. Western nations are supplying advanced weapons to Ukraine including missile defense systems, hi-tech powerful armoured vehicles and if President Volodymyr Zelenskyy gets his way, F-16 fighter jets as well. That is not making Russian President Putin very happy.
If he escalates or expands the hostilities, a lot more than supply chains will get disrupted.
The Middle East is always a source of geopolitical tension, and those tensions are aflame once more. Protestors are out in force in Iran defying the Ayatollahs and the Revolutionary Guard.
Israel reportedly launched a drone attack on an advanced weapons production facility in Iran in an ongoing effort to degrade Iran’s military capabilities.
Oil prices do not seem to have a lot of downside. Opec expects Chinese demand to rebound as the country reopens its economy and the International Energy Agency is forecasting a 1.9 million barrel/day increase in 2023 demand while Opec does not have plans to increase production.
Rising geopolitical tensions and higher oil prices are inflationary which should limit or prevent, any Fed rate cuts this year.
Fading these moves may be a reasonable course of action. We may be getting close, but the Fat lady isn’t even on stage yet.