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Fed turns less hawkish, hikes just 25 bps

3 Feb 2023 , 09:31 AM

The first meeting of the US Federal Reserve concluded on 01st February 2023. Indian investors cannot be blamed for missing the Fed statement in the midst of the flurry of activity caused by the Union Budget and the Adani Enterprises FPO cancellation. However, the Fed has stuck to its promise of slowing on rate hikes and has hiked rates by just 25 bps. This takes the rates to the range of 4.50% to 4.75%. Effectively, since March 2022, the Fed has hiked rates by a full 450 basis points. Fed has also affirmed that it sees another 2 rates hikes of 25 bps each taking the terminal rate to the range of 5.00% to 5.25%.

In the December 2022 Fed meet, the Fed had hiked rates by 50 bps, a slight departure after 4 consecutive meetings had seen 75 bps rate hike each. Now the February meet has further reduced its rate hike intensity to 25 bps. While the inflation has shown signs of coming down, the Fed would still be observing the core inflation data closely and also focusing on the labour data, which has been too strong for far too long.

A quick detour to what the CME Fedwatch is saying

CME Fedwatch reflects implied probabilities of future rate hikes based on Fed futures pricing. The table below captures the live probabilities of different rate levels after the various Fed meets in year 2023.

Fed Meet

375-400

400-425

425-450

450-475

475-500

500-525

525-550

550-575

575-600

Mar-23 Nil Nil Nil 17.3% 82.7% Nil Nil Nil Nil
May-23 Nil Nil Nil 10.5% 56.8% 32.8% Nil Nil Nil
Jun-23 Nil Nil Nil 10.0% 54.8% 33.8% 1.4% Nil Nil
Jul-23 Nil Nil 2.5% 21.1% 49.6% 25.7% 1.0% Nil Nil
Sep-23 Nil 1.0% 9.9% 32.5% 40.1% 15.8% 0.6% Nil Nil
Nov-23 0.4% 4.7% 19.3% 35.7% 30.0% 9.5% 0.4% Nil Nil
Dec-23 4.7% 17.9% 34.1% 30.5% 11.5% 1.25% Nil Nil Nil

Data source: CME Fedwatch

One thing is evident that the market is becoming less hawkish with the passage of time and to that extent, the Fed has surely managed a smooth communication with the markets. Now, the CME Fedwatch is also hinting at a worst case hike of another 50 bps from here. Here are some key takeaways from the CME Fedwatch probabilities.

  • The markets are factoring in another 50 bps of rate hike in the year 2023, but what we do see is a greater ambivalence between a 25 bps rate hike and 50 bps rate hike from here. Clearly macro GDP data will play a key role.

     

  • The probabilities have narrowed and the markets have called a top to hawkishness at a rate range of 5.00% to 5.25%. Markets don’t see the rates going really higher than that in the current year.

     

  • Despite the Fed minutes ruling out rate cuts in 2023, the CME Fedwatch is factoring in a likelihood of 25 bps to 50 bps rate hike in the second half of the year. Again, this would be contingent on the GDP data and the risk of a slowdown.

     

  • The broad trajectory for the terminal rates still remains in the range of 5.00% to 5.25% with a strong likelihood that rates could be cut in the second half. The markets are not ruling out rates below 5% by the end of the year 2023.

Two things emerge from the CME Fedwatch. The US central bank is still not done with hawkishness; at least till the impact on inflation is palpable. Secondly, the probability of a broad-based recession in the developed world is gaining ground.

What we read from the Fed statement

Here are some key takeaways from the Fed statement issued post the FOMC meet, late on 01st February 2023.

  1. The tone of the debate has now shifted from how much more rate hikes, to when the Fed rate hikes would stop. There is almost a consensus and that is also the indication from FOMC members, that rates may not go up more than 50 bps from current levels. 

     

  2. The rate hike intensity has tapered from 75 bps to 50 bps in December and further to 25 bps in February shows the FOMC is on a tightrope walk. It has played the inflation game too long, and now has to unmount without triggering inflation or a recession.

     

  3. However, despite indications from the CME Fedwatch, the Fed has not committed to any firm date or a firm terminal rate for the year. The only thing it has committed is that the rates would continue to remain high till inflation continued to be a macro challenge.

     

  4. Jerome Powell was quite insistent that rate cuts were not in the offing and even took pains to walk the fine line between the flow of data showing inflation in steady decline with the need to keep the public and investors sold on to the idea of rising rates.

     

  5. The Fed wants to rethink its rate hike policy only after the inflation showed distinct signs of moving towards the 2% mark. While the Fed has ruled out any rate cuts in year 2023, the CME Fedwatch even appears to factor in a likely 25 to 50 bps rate cut in this year.

     

  6. The Fed statement has pointed out that while inflation has tapered in the products segment, it is yet to taper in the services segment, which is what the Fed would like to see happening. Also, wages are too strong to support lower inflation.

     

  7. On the labour market, Powell has pointed out that more than 11 million jobs were added in the last 2 years and the unemployment rate is now down at a low of 3.5%. Unless this bounces, it is unlikely that inflation can start its journey towards 2% mark.

     

  8. One thing the Fed did affirm is the focus on inflation targeting. However, the Fed has assured that future hikes would only be in 25 bps each. The Fed is likely to complete the rate hikes in the first half of 2023 itself, giving them enough time for a relook, if needed.

One thing emerges from the Fed statement. This may not be the end of rate hikes, but it is surely the beginning of the end of rate hikes in the US. A lot will depend on inflation levels.

What are the takeaways for the Indian markets?

A key factor in this entire equation is how the RBI reacts to the Fed statement. For now, it looks like the RBI may pause in February and keep the options open for another 25 to 50 bps rate hike in subsequent policy statements. Fed stance has not been too clear, but it looks like the Fed may be just about 50 bps away from the terminal peak rates of interest. That is good news for the Indian markets as it circumscribes the overall risk.

In terms of FPI flows, the outflows have again resumed since the start of January 2023 with FPIs selling more than $3.52 billion in the first month of 2023. For now, liquidity is a concern and some toning down of valuations may be on the cards. For India it is time to focus on policies that are a lot more inward looking. A flow policy that is risk-off versus risk-on dependent is not going to work for India in the long run.

Related Tags

  • FED
  • monetary policy
  • Rate hike
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