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* The US Federal Open Market Committee (FOMC) raised its policy Fed Funds rate by 25bp to 4.75-5% (as we had expected Link), and retained its schedule of quantitative tightening (monthly reductions of its bond portfolio). But it also emphasised that recent turmoil in the banking system will necessarily tighten credit conditions. Since the degree of this banking-related credit tightening is uncertain, future policy actions will be data-dependent. The FOMC’s median forecast for the Fed Funds rate at end-CY23 remains unchanged, implying another 25bp hike in CY23.

* Chairman Powell emphasised that no rate cuts are in the FOMC’s baseline for CY23, especially since inflation remains too high and the labour market very tight. We continue to expect the US recession to begin in Q2CY23, given that the key recession predictor – an inverted 10-year minus 2-year yield curve – first occurred a year ago, and has consistently been inverted since 5th Jul’22. The tightening in credit conditions is likely to deepen and hasten the recession, generating slack in the labour market, which will help to gradually lower core PCE inflation. In particular, the ongoing weakness in the US housing market will flow through to lower shelter inflation over the next half year, bringing down headline and core inflation.

* We have been skeptical about the FOMC’s forecasts over the past 15 months, but think the Fed is now realistic. Monetary tightening remains necessary to fight exceptionally high inflation, but some of the Fed’s work will be done by the tightening in credit conditions amid the turmoil in the US banking system, which will also push the economy into recession. Inflation, resulting from excessively rapid M2 growth in Mar’20-Feb’22 (averaging 18.2% YoY over the 2-year period, vs an average of 6.8% YoY in the previous 60 years pre-covid), is still too entrenched to warrant any rate cuts over the next 12 months. A bit more monetary pain lies ahead, with easing unlikely before Q2CY24 despite the intervening recession.

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