FOMC: As you were

Key takeaways:

• The FOMC announced a return to its rate hiking policy, following its June ‘pause’, with a unanimous decision to raise the Fed Funds Rate by 25 basis points (bps) to 5.25% - 5.50%.

• The Federal Reserve’s decision to raise rates to their highest level in 22 years was also accompanied by a prepared statement and subsequent press conference from Chairman Powell, reaffirming that further rate hikes would be dependent on the latest economic data.

• Markets were widely expecting today’s rate hike with little price action seen in equity markets. Treasury yields also fluctuated lower over the course of trading. 

What happened?

Today the FOMC announced its decision to raise the Fed Funds Rate by 25-basis points, reaching a target range of 5.25% - 5.50%. The move higher in rates follows on from the committee's decision to pause its rate hike policy during last month’s FOMC meeting.
 
In one of two slight changes to the June statement, the committee highlighted that economic activity has continued to expand at a “moderate” pace, a change from “modest”, over the course of 2023. Highlighting the continued gains made in the labor market as well as persistent inflation levels, the FOMC also altered its previous statement confirming that the committee “will continue” to assess additional information over the coming months and will “be prepared to adjust” monetary policy when necessary.
 
During the press conference, Chairman Jerome Powell continued to emphasize several of the driving forces behind the elevated inflation levels, including the strength of the labor market as well as a pickup in housing activity. Whilst agreeing that inflation levels had moderated since last year, Powell also stated that monetary policy had not been “restrictive enough for long enough” in order to have the desired effect. Powell further acknowledged that bringing inflation down to their target level of 2% will require economic growth to slow over the coming quarters with the labor market especially, needing to show signs of weakness.
 
Over the course of the Q&A session, Chairman Powell was pressed on how the committee were viewing future FOMC meetings with the possibility of further rate hikes still being considered. Powell reiterated the FOMC’s commitment to data dependency, stating that further tightening decisions will be taken on a “meeting-by-meeting” basis. With such a focus on further rate hikes, Powell further reminded his audience that another ‘pause’ was also a possibility. Such a comment was, in turn, interpreted by markets as a potential skip in September before further hiking rates at the November meeting.  

How did markets react?

In the build up to the rate decision, stocks were trending lower in both U.S. and European markets. Another factor playing its part in market direction was the ongoing earnings releases, with particular focus on the mega-tech names that have dominated returns thus far this year. 
 
Markets turned positive during Powell’s press conference, with investors taking today’s announcement in its stride. For the FOMC, the next important data points will be the latest Nonfarm Payrolls (August 4th) and CPI (August 10th) reports. 

What does it mean for investors?

As it turned out, the much discussed ‘pause’ that was announced at last month’s FOMC meeting turned out to be just a ‘skip’ as the Federal Reserve resumed its rate hiking with a further 25 bps move higher to the Fed Funds Rate. Following today’s decision, the range is now at its highest since 2001.
 
In recent weeks, investors have revisited the possibility of the Federal Reserve delivering a ‘soft landing’ whereby the U.S. economy is able to avoid recession as the central bank delivers rate hikes to tame inflation. Certainly, we have seen headline inflation rates come down from their post-COVID highs (currently annualized U.S. CPI sits at +3.0%) but concern remains within the Core component of inflation, stripping out both Energy and Food.
 
With labor markets remaining tight (unemployment at an historically low +3.6%) and strong year-on-year wage growth (+4.4%) still feeding into the services elements of inflation, Chairman Powell is staying on the side of data dependency before any victory can be claimed in the battle against inflation. The subtle changes to the Fed’s statement today allude to this commitment, while also using his press conference to focus attention on a possible further hike later in the year.
 
The risk of market complacency around ‘calling’ the end of the Fed’s rate hikes has had precedence in recent months. Following pressures within the regional banking sector in March and subsequent rate hike by the FOMC, the probability of further rate hikes fell to 25% according to futures markets. As such, as regional banks stabilized, inflation remained elevated and further hikes were delivered in May.
 
With inflation levels remaining above the desired +2% target, the possibility of further rate hikes should not be taken off an investor's table. In fact, based on the previous 12 cycles, the Federal Reserve have only ever cut rates with Core CPI above +3%, when the unemployment rate was also above +5%.  
 
Following its 25-basis point hike, the Federal Reserve reiterated its desire to remain data dependent in bringing inflation down to target. Elevated labor and price data will keep the potential of further hikes “on the table”. 

The CIO Memo above is available to download. Please refer to the Important Information at the end of the memo for disclosures and risk warnings.

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