Below is Perspective note on FOMC By Ms. Madhavi Arora, Lead Economist, Emkay Global Financial Services
FOMC: Hopeful Hawks
■ The Fed delivered a well-telegraphed 25bp hike, but the rest of the communications were more hawkish with a heavy focus on achieving price stability. Everything else from the FOMC—the dots, the post-meeting statement, balance sheet policy—probably skewed a little more hawkish than expectations.
Chair Powell pledged that the Fed would be nimble given risks from Ukraine’s invasion by Russia, but cited solid growth and a tight labor market, in addition to continued upward pressure on inflation, as warranting “ongoing increases” in the policy rate.
■ The median dots now show seven 25bp rate hikes for this year (including the hike just delivered) —a full percentage point above the prior projections from December. With 7 out of 16 members looking for such a move, this adds credence to the idea that at least one 50bp is a live possibility later this year. This was also repeatedly highlighted by Powell if inflation does not align with FOMC’s expectations.
■ The year 2023 sees median 3.5 more hikes in 2023, with policy remaining restrictive at 2.75% through end-2024 – against a slightly lower median neutral long-run dot at 2.4%.
Even so, the message from Powell and the FOMC forecasts is that the expected hikes will achieve disinflation without much slowing in growth or increase in unemployment. Powell remarked that labor market tightness was “unhealthy,” but it doesn’t look like that’s going to change.
■ Powell also strongly hinted at balance sheet reduction beginning in May, stating that the Committee had made good progress on operational details. He flagged that additional information on runoff would be revealed in the upcoming minutes (in three weeks’ time).
■ The statement reintroduced forward guidance by saying that the Committee “anticipates that ongoing increases in the target range will be appropriate.”
Another signs of hawkishness was that inflation is now seen “broader price pressures,” implying it is now due to more than pandemic-related imbalances and thus is unlikely to subside quickly/easily. There was also mention that the Russian invasion of Ukraine would add to inflation and subtract from growth.
■ Inflation was revised up sharply 170bps for ’22 to (4.1%), while it remains above 2% in the forecast horizon. Growth slashed down by 120bps for ’22 (2.8%) and unchanged for rest period and above the potential growth, 1.8%, indicating that the upward revisions to the outlook for the policy rate into restrictive territory did nothing to affect the expectation for above-trend growth the next two years.
We note their estimates of appropriate funds rate is largely on hold in ’24 even as inflation was revised up to 2.3%, partly implying their level of tolerance for above-2% inflation.
■ Post policy, US duration sold off meaningfully as the curve initially bear-flattened and then later twist-flattened. Equities likely found inspiration from Powell admitting “it may take longer than we like” to bring inflation down which was perhaps interpreted as a slower, longer hiking cycle to support a “sustained economic expansion.” The risk-on tilt was likewise evident in credit spreads while the DXY Index collapsed from 99 as low as 98.30, closing 0.7% lower.
■ G-4 CB space is largely getting synchronised. Following last week’s hawkish tone from the ECB, and Fed’s hike, BoE will likely follow suit today, while BoJ is likely to remain on hold.
EM CB space remains divergent, where EM Latam has been raising rates (Brazil hiked today by 100bps – 9th consecutive hike) , while lower inflation keeps EM Asia CBs more growth focussed even with a hawkish Fed.
We note India again stands out in EM Asian space with 6%+ inflation but a restrictive and accommodative policy stance in line with EM Asian CBs (reminiscent of Covid period), with possibly the exchange rate bearing the price of the sticky monetary policy.
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