Market Wire: Federal Reserve hikes rates, retains optionality ahead of September meeting

The Federal Reserve’s policy committee raised benchmark rates to a 22-year high this afternoon, and left its options open for September, broadly aligning with economist forecasts and leaving markets relatively untroubled. At the conclusion of its two-day meeting in Washington, the Federal Open Market Committee unanimously voted to lift the target range for the federal funds rate to 5.25-to-5.50 percent - the highest since 2001, with no dissents in favour of a smaller or larger move.

In the statement setting out the decision, policymakers acknowledged “moderate” growth in the economy, “robust” job gains, and “elevated” inflation, before observing that “Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation,” although “the extent of these effects remains uncertain”.

Mirroring language used in previous releases, officials kept additional rate hikes on the table, saying “In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.

This comes after a wide range of data releases from most major economies in the last few weeks pointed to a sharp deceleration in global inflation pressures, with all of the major central banks now seen ending their monetary tightening campaigns within months. But core inflation remains sticky, and policymakers - heeding the lessons of the seventies - remain reluctant to sound the “all-clear” signal, and are working assiduously to avoid an unwarranted and undesired loosening in financial conditions.

Markets are reacting cautiously, with key measures of risk appetite remaining relatively stable as traders leave terminal rate expectations unchanged. US equities are holding firm as two- and ten-year government bond yields tick incrementally lower and the dollar fades slightly.

Focus is now shifting to the press conference, where Chair Jerome Powell is expected to express relatively-hawkish views on the outlook for growth, employment, and inflation - while also articulating a data-contingent approach to setting policy that could see the Fed stay on hold through the autumn months. If the past is prologue, big jumps in the dollar over the trading cycle should be viewed with suspicion - investors  have bid the greenback higher in the hours after many of Powell’s post-pandemic press conferences, only to reverse direction on more careful reflection.

More broadly, markets remain inclined to expect a quick shift to easier monetary policy settings in early 2024. We remain inclined to expect a longer “plateau”, with rates ultimately falling by less than the current consensus suggests.