The Fed’s Future Monetary Policy Changes Become Clearer – Analysis
By Wei Hongxu
On February 1, the Federal Open Market Committee (FOMC) announced after the meeting that the target range of funds rate was raised from 4.25% – 4.50% to 4.50% – 4.75%, and the interest rate increase was 25 basis points. This is the second time in a row that the Federal Reserve has slowed the pace of rate hikes. Although there were various speculations before the meeting, the Fed’s interest rate hike is still in line with the expectations of most market institutions.
For the researchers at ANBOUND, the difference between the Fed and the market still lies in the trend of future inflation and when the Fed will end its interest rate hike cycle. The previous intense interest rate hike has dealt a great blow to the capital market, causing the U.S. stock market to drop sharply last year. The market naturally hopes that the Fed can end the rate hike cycle as soon as possible for the capital market to recover. However, from the Fed’s perspective, it is still necessary to consider the impact of inflation on the entire economy, yet with the glooming shadow of the economic recession, it also hopes to appease the sentiment of the capital market and avoid things worsening. In fact, since the end of last year, when the Fed slowed down the pace of raising interest rates, the market has become more optimistic about the U.S. inflation situation and the Fed’s monetary policy shift, which has also brought about a change in market sentiment.
In this regard, the view on inflation in the Fed meeting minutes has changed, stating that “Inflation has eased somewhat but remains elevated”. However, the Fed is still concerned about the stickiness of inflation and wants to raise and keep interest rates restrictively. For now, it appears that the economic slowdown is still playing a secondary role in policy implications. Fed Chair Jerome Powell said that compared with growth risks, the Fed pays more attention to inflation risks. Policymakers believe that the risk of excessive interest rate hikes is controllable, and the failure of policies to contain inflation will create uncontrolled expectations, which may bring higher macro costs. As for the direction of future policy, he said “the actual outcome is data dependent”.
With inflation falling from a high level, the future direction of the Fed’s monetary policy, as well as its room for raising interest rates, has become clearer. Most of the current expectations, including that of the Fed itself, are that the Fed will continue to raise interest rates by 25 basis points before peaking. What is difficult for the market to effectively judge is the time for interest rates to remain high. There are optimistic expectations that interest rate cuts will begin in the second half of the year, but the Fed still emphasizes controlling inflation within the target range. This is an indication that it is unlikely to push for rate cuts in 2023. Tao Dong, an analyst at Credit Suisse, believes that the Fed’s new interest rate hike decision, on the one hand, has returned to the traditional rate hike intensity, and on the other hand, attempts to manage market expectations for interest rate cuts. This will be the focus of the game between the market and the Fed.
In the opinion of researchers at ANBOUND, the Fed’s first monetary policy meeting this year did not bring too many surprises. Rather, it continues to gradually slow down the interest rate hikes along the path it proposed last year. In addition, it appears to make more flexible adjustments depending on changes in inflation and the economic situation, to achieve a soft landing. All in all, its future policy trends and space appear to be more stable. This means that there is less and less uncertainty about Fed policy changes.
Due to the dominant position of the Fed in global monetary policy decisions, the gradual formation of its policy interest rate sets a benchmark for the peak of monetary policies of various countries. This trend means that in 2023, the impact of the monetary policies of countries on the global economy and financial markets will become clearer, and the predictability of economic development will continue to increase.
Currently, the only variable is the extent of the decline in U.S. economic growth under the potential energy of high-interest rates. As far as this year is concerned, on the one hand, the level of inflation in the U.S. will gradually fall, and on the other hand, under the high pressure of interest rates, its economy will also fall, even into a technical “recession”. In this regard, the Fed’s previous intense interest rate hike was to create a “time gap” between inflation and economic growth, to achieve a soft-landing policy idea. This rational situation means that the Fed has a balance between the market and policy. However, if the Fed, as it did before raising interest rates too late, lags behind changes in inflation, and fails to push for a rate cut after inflation falls back into its policy target, this may cause deeper damage to the U.S. economy. This is theoretically likely to happen under the Fed’s new policy framework of average inflation targeting currently in place. Hence, the risk of U.S. economic recession is what the market fears the most under the current policy trend. As things stand, the Fed will continue to maintain a prudent and flexible attitude within the framework of curbing inflation and maintaining growth.
Final analysis conclusion:
At the very first policy meeting in 2023, the Federal Reserve decided to continue raising interest rates by 25 basis points, mainly due to the fall in inflation from its high level. This decision in line with expectations means that the trend of the Fed’s monetary policy this year has become clearer, and the risks brought about by policy changes are gradually decreasing. The future risk lies in the degree of decline of the U.S. economy under high-interest rates, which is the key to when the Fed will end its interest rate hike cycle.
Wei Hongxu is a researcher at ANBOUND