Coming up: Two more rate hikes by the US Fed this year

The Federal Open Market Committee voted to hold rates at 5-5.25 percent in June to assess the impact of the past 10 cumulative rate hikes of 500 bps, but ruled out rate cuts for the next couple of years until inflation comes down meaningfully. July's policy decision remains uncertain

By Neha Bothra Forbes India Staff

Published: Jun 15, 2023 12:33:47 PM IST

Updated: Jun 21, 2023 06:31:22 PM IST

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Federal Reserve Chairman Jerome Powell Image: Kevin Lamarque / Reuters

The US Federal Reserve’s decision to keep the benchmark rate unchanged at around 5.1 percent, its highest level in 16 years, after cumulative rate hikes of 500 basis points over 15 months, came as a respite for the markets. But the respite was rather short-lived as investors were left wondering if the move to hold rates was a ‘skip’ or a ‘pause’ as the central bank’s June dot plot—an outlook for monetary policy—indicated two more rates hikes ahead this year.

“Nearly all committee participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year. But at this meeting, considering how far and how fast we’ve moved, we judged it prudent to hold the target range steady,” Federal Reserve Chairman Jerome Powell said.

The policy outcome was interpreted as hawkish by investors, and stocks lost early gains in trade, but recovered after the central bank reiterated that the committee would assess the impact of the rate hikes so far as the effects of policy tightening and demand in interest rate sensitive sectors such as housing and investment would take time to bear an impact on inflation.

“We have raised our policy interest rate by 5 percentage points, and we’ve continued to reduce our security holdings at a brisk pace. We’ve covered a lot of ground and the full effects of our tightening have yet to be felt,” Powell explained.

The Federal Open Market Committee (FOMC) said holding the target range steady at this meeting allows the committee to assess additional information and its implications for monetary policy. Importantly, it signalled that the rate cut cycle is far-off even though Powell suggested that the conditions that would be needed to get inflation down are coming into place.

Clearly, consumer inflation fell from a 40-year high of 9.1 percent in June last year to 4 percent last month. However, core inflation remained sticky at 5.3 percent in May, and the US Federal Reserve aims to rein in inflation at 2 percent.

“As anyone can see, not a single person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate. It will be appropriate to cut rates at such time as inflation is coming down really significantly. And again, we’re talking about a couple of years out,” Powell said.

The market was hopeful that lower-than-expected inflation at a two-year low of 4 percent would give Powell room to be relatively dovish given an overall challenging macroeconomic environment. However, these expectations were crushed as the US Fed forecast that it would raise interest rates to 5.6 percent by year-end. Crude oil prices declined by 1.5 percent as global economic recovery is likely to be hit.

Also read: RBI on a hawkish pause; aims to achieve 4 percent inflation

Wall Street closed on a mixed note as the Dow Jones Industrial Average fell nearly 233 points, while the S&P 500 and the Nasdaq Composite Index rose by 3.38 points and 53 points respectively. By and large, Asian markets opened in the green: Nikkei was up 0.3 percent, Hang Seng gained 0.7 percent, the Shanghai Composite rose around 0.2 percent, but the S&P BSE Index opened about 0.2 percent lower.

Deepak Agrawal, CIO- fixed income, Kotak Mahindra AMC, says, “The FOMC surprised markets with a hawkish pause, projecting two rate hikes in 2023, contrary to the expected one rate hike. We expect a final hike in July to 5.25-5.5 percent, but anticipate a subsequent hold for the rest of 2023 because core inflation would have come meaningfully lower.”

What mainly spooked investors is that persistently high rates could further slow down the economy. Experts recall the last three rate hiking cycles wherein the FOMC waited at least seven months after the last rate hike to reduce rates. Moreover, Fed Chair Powell refrained from giving cues about the July policy outcome.

“We didn’t make a decision about July. I would say two things: One, a decision hasn’t been made. Two, I do expect that it will be a live meeting,” Powell said.

The US Fed agreed that tighter credit conditions would put pressure on investment and consumption, and slow down the economy, but was uncertain about the degree of its impact. It forecast unemployment to average 4.1 percent in the fourth quarter versus its 4.5 percent estimate in March. In May, government data pegged the unemployment rate at 3.7 percent. The central bank raised its GDP growth outlook to 1 percent from 0.4 percent in March.