Yesterday’s announcement that the Federal Open Market Committee (FOMC), the monetary policy setting committee within the US Federal Reserve (Fed) raised rates to a range of 1.50-1.75%, a 75 basis points (bps) increase, certainly shows that they’re now getting serious in the fight against inflation.
But what do investment experts think of the news and what are the implications of it for investment and markets? We share a selection of comments from leading experts:
Phil Milburn, co-manager in Liontrust’s Global Fixed Income Team commented that ‘markets love it’ as he points out how the Fed has gone about reclaiming its ‘hawkish credentials’:
” This 75bps hike by the Fed was 100% priced into the very short end of the market. After the upside surprise to US consumer price inflation (CPI) data on Friday the Fed clearly needed to act to regain some hawkish credentials. What I would view as a very well-placed article appeared in the Wall Street Journal on Monday 13 June stating the Fed officials would consider “surprising markets with a larger-than-expected 0.75-percentage-point interest-rate increase at their meeting this week.” This is ironic, as the clear aim of the article was to ensure that a 75bps hike was not a surprise!
“The FOMC members’ core PCE projections were nudged upwards by 0.2% this year to 4.3% and 0.1% in 2023 to 2.7%. Headline PCE (personal consumption expenditures, the Fed’s preferred inflation measure) forecasts jumped from 4.3% to 5.2% for 2022 but converge to similar levels to the core PCE figures thereafter. The minutes clearly state that the “…Committee is strongly committed to returning inflation to its 2 percent objective.”
“In terms of how they are going to achieve this, they are heading rapidly towards a restrictive monetary policy setting. There was a well-anticipated big jump in the dots, with now more clustering around the median; the yellow dots are from the June 2022 economic projections, the grey dots are from the prior projections in March 2022. As a reminder these dots are the FOMC members’ projections, with the median (green line) representing a guide to where the consensus will probably be. They show a further 175bps hikes predicted for this year to have Fed Funds finish 2022 in the 3.25% to 3.50% range. 2023 then sees an additional 50bps of hikes which are reversed in 2024. At the time of writing of 8-9pm on the 15th June both equity and bond markets like this approach, raising rates more rapidly sooner should lead to a lower peak in rates and less long-term damage to the economy. I mention restrictive territory as the dots on the right-hand side of the graph show where the Fed members believe long-term neutral rates to be, namely 2.50%. Furthermore, the Fed has now started shrinking its balance sheet with every $1 trillion estimated to produce the equivalent of another 25bps hike.
“Although the Fed is late to the table in tackling inflation, they are now showing they are taking the matter seriously. We have been saying that the US economy can cope with rates at higher for longer in the neutral range around 2.50%; but a peak in rates of 4.0% will slow the economy significantly. It would create the rise in unemployment, that then dampens down wage inflation, and puts a halt to the feedback loop that is currently driving inflation expectations.
“Ahead of the Fed meeting with US 10-year yields close to 3.50% we believed sovereign bond markets were starting to offer decent value. So, on the morning of Wednesday 15 June we took our strategic bond funds to a neutral duration position of 4.5 years. Whilst normally nobody wants to read any comments about a fund manager being neutral, I felt that this one was worthy of a mention. It is my first time in over a decade of not being underweight duration risk, the previous occasion when the strategies were a little long duration was way back during the Sovereign Crisis of 2011. A hawkish central bank looking to tame inflation is what many bond managers have been clamouring for.”
Fidelity International’s Global Head of Macro & Strategic Asset Allocation, Salman Ahmed, remains cautious and sees tough times ahead commenting:
“We continue to think that the ongoing aggressive tightening in financial conditions (which is significantly higher than 2013 and 2018 given higher inflation) will likely to lead a serious and sharp slowdown in growth in coming months. We think a lot of the hawkishness the Fed is displaying right now is already priced in and interest rate sensitive sectors such as housing are likely to feel the pressure in a sustained way. Moreover, we are already seeing signs of consumer weakness as the collapsing confidence we have been picking up through our trackers is turning into hard data (for example, the latest retail sales print). Lastly, given very high debt in the system, there is a limit to how much further real rates can move up. We are already seeing debt financed balance sheet issues playing a big role in shaping ECB policy, which is now likely to do hiking alongside some version of QE going forward in order to keep financial stability intact in the euro area.
“We remain cautious with underweights in equities and credit. We are also underweight in US versus other DM countries in fixed income. As we pass through this phase of strong hawkishness, we think this set-up of views makes sense. Already, we think that credit markets remain vulnerable given the scope for a serious slowdown and recession the current Fed induced tightening can precipitate. However, we also think we are nearing the point where damage to growth which is in the pipe-line will start to dominate inflation as the primary concern for both policy makers and markets.”
Richard Carter, head of fixed interest research at Quilter Cheviot, sees the action as showing that the Fed is having to make up for lost time in the battle against inflation commenting:
“The Federal Reserve has decided now is the time to up its aggressiveness in the battle against inflation. Choosing to raise interest rates by 75bps looks justified given the unrelenting inflation pressures being seen in the US at the moment. Last week’s inflation print caught people by surprise and it has been disappointing not to see inflation start to fallout the system.
“There is no doubt that the Fed got themselves behind the curve on inflation and are now having to make up for lost time and we expect to see several more rate hikes before the year is out. Inflation has been stickier and more persistent than was expected, so it is unlikely now that this problem will simply just dissipate quickly over the second half of the year. High oil prices continue to keep inflation elevated and there are fears that as China switches back on following various lockdowns we will get another demand shock and this could make inflation remain stubborn.
“Investors are understandably concerned that such a sharp pace of monetary tightening will lead to a recession and markets are likely to remain volatile until we reach a peak in inflation. In the near term equity markets, and in particular growth companies, are unlikely to react well to this news, while bond yields will continue to trace higher for as long as inflation remains an issue the Fed feels it needs to specifically attack. While the current market is difficult for investors, what this does show is the importance of having a well-diversified portfolio and the protection it can provide.”
Allison Boxer, US Economist at PIMCO sees this tightening continuing for the next few meetings as she comments:
“A historic FOMC meeting results in a 75 basis point rise in rates and a revised dot plot suggesting aggressive monetary policy tightening is likely to continue for the next few meetings.
“Revised forecasts for growth and the unemployment rate in the Summary of Economic Projections (SEP) suggest that the Fed is starting to acknowledge that a faster path of monetary policy tightening will come at the cost of slower growth and higher unemployment. Fed now expects U.S. GDP to grow 1.7% in 2022 and 2023, down significantly from 2.8% and 2.2%, respectively. Unemployment is also expected to rise from current levels.
“The ‘dot plot’ showed the Fed is unanimous in thinking the funds rate needs to get above their estimates of neutral by year end. But only a few officials expect rates to peak meaningfully above what was already priced into markets.”
Charles-Henry Monchau, CIO at Syz Bank in Geneva, proclaims it as a “hawkish” message from the Fed as he shared the Bank’s views and points out the risks of the Fed’s strategy:
“In general ways, we are not overly surprised by this announcement. Our view remains unchanged. The Fed is now firmly resolved to conduct a restrictive monetary policy via rapid and pronounced tightening in order to bring down inflation. The 75bps becomes the new 50bps.
“The risk of this strategy is obviously a severe slowdown in economic growth – or even a recession. Risky assets could therefore suffer further, while the long end of the US treasury bond curve could soon offer buying opportunities.
“On the positive side, the fact that the Fed is now very quickly aligning itself with market expectations shows that it is determined to regain credibility. It is rather well taken this evening on the markets.
Beware of collateral risks: the last time we had a 75 basis point hike from the Fed, the corollary was the Tequila crisis with a bailout of Mexico by the IMF…”