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Markets welcome ‘friendly’ decision as Fed holds rates

By Rhea Nath
5 minute read

While the Federal Reserve opted for a hold in its March meeting, its dovish tone suggests a quiet confidence for a soft landing ahead, according to market watchers.

The US central bank has signalled that rates are likely at their peak for this tightening cycle, choosing to maintain rates at 5.25–5.5 per cent in its latest meeting.

The move occurred a day ahead of the Bank of England’s expected decision to maintain its interest rate at 5.25 per cent and followed the Reserve Bank of Australia’s recent decision to also hold rates.

In his opening statement, Fed chair Jerome Powell said it will likely be appropriate to begin dialling back policy restraint later this year, if the economy evolves broadly as expected.

He observed the bank’s “restrictive” stance on monetary policy has been putting downward pressure on economic activity and inflation and the risks to achieving its employment and inflation goals are “moving into better balance”.

However, the economic outlook is “uncertain”, he contended.

“We remain highly attentive to inflation risks [and] we are prepared to maintain the current target range for the federal funds rate for longer, if appropriate,” he told reporters.

“We know that reducing policy restraint too soon or too much could result in a reversal of the progress we have seen on inflation and ultimately require even tighter policy to get inflation back to 2 per cent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.

“In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”

US GDP growth came in at 3.2 per cent in the fourth quarter of last year. For 2023 as a whole, it expanded 3.1 per cent, bolstered by strong consumer demand as well as improving supply conditions.

Meanwhile, inflation stood at 3.2 per cent in February, up from 3.1 per cent in January, as petrol and housing prices pushed the rate higher.

Powell’s remarks indicated that the central bank does not anticipate reducing the target rate range until it is more confident that inflation is steadily decreasing towards 2 per cent.

“Of course, we are committed to both sides of our dual mandate, and an unexpected weakening in the labour market could also warrant a policy response. We will continue to make our decisions meeting by meeting,” he said.

A market-friendly decision

Principal Asset Management’s chief global strategist, Seema Shah, believes markets “couldn’t really have hoped for a more market-friendly Fed decision”.

“To no-one’s surprise, the Federal Open Market Committee chose to keep the benchmark policy rate,” she said.

“More significantly, the latest dot plot revealed the committee continues to expect 75 basis points of cuts this year. That is despite recent upside inflation surprises as well as upward revisions to both its GDP growth and inflation forecasts.”

This is a Fed that wants to reduce interest rates, she asserted.

“The past few months have been a particularly volatile period for Fed forecasts. As recently as early February, financial markets were convinced that the Fed would cut policy rates at least six times this year. Yet the hot January and February inflation and jobs reports prompted markets to significantly revise their expectations, bringing them in line with our own forecast for three cuts this year, starting in June,” Shah explained.

“In the last week, there has been growing speculation that the latest inflation prints represented a setback to the Fed’s efforts to reach the 2 per cent inflation target and, as such, the Fed’s dot plot may see one cut removed this year.”

In fact, the Fed maintained its median forecast for three cuts this year, suggesting that it believes the recent inflation prints may have potentially been distorted by seasonal effects.

“As a result, the broader picture of disinflation has not changed,” Shah said.

American Century Investments also observed the cumulative effects of rising prices and high interest rates weighing on consumers means that a slowing economy and mid-year Fed easing are likely on track.

“If these trends persist, the Fed will have little incentive to keep its target rate at the current 23-year high range,” said John Lovito and Charles Tan, co-chief investment officers at the firm.

“Consumers power the US economy, and as wage growth slows and savings diminish, we expect GDP to succumb to weaker spending.

“Additionally, the strength characterising the post-pandemic job market appears to be waning, potentially removing one of two factors keeping Fed policy restrictive. The other factor – inflation – remains higher than the Fed would like, but prices may ease further as spending slows and the economy weakens.”

Ray Sharma-Ong, investment director of multi-asset at abrdn, agreed that inflation continues to be front and centre for the central bank.

“The Fed’s decision to maintain three rate cuts this year was a close call with nine out of 19 voting members indicating two rate cuts or less in 2024. This increases the importance of the upcoming inflation reports as to whether the first rate cut will take place in June this year,” he stated.

He foresees front-end and back-end yields to moderate in the months ahead, given the Fed’s dovish tone towards rate cuts.

“With yields having scope to fall further from current levels, we expect higher yielding Asia credit to outperform. In addition to bonds benefiting from fall in yields, this also benefits long-duration equities, and regions with high exposure to tech stocks. This would favour regions like Korea and Taiwan, and sectors like Asia REITs,” he said.

Moreover, with lower expected US yields, the rate differential between US and Asia will narrow, benefiting currencies like the Indonesian rupiah, Indian rupee, new Taiwan dollar, and South Korean won.

PGIM Fixed Income’s Robert Tipp believes the Fed’s latest decision comes at a buy point for fixed income.

Strategically, coming to the end of the Fed rate hiking cycle is where investors are going to be seeing the peak in interest rates, he explained.

“That was probably at the end of September last year. We were getting into that buy zone at the end of 2022. We remain there now,” Tipp remarked.

“We’re seeing a lot of support for the market. That’s why the risk premiums in the market are so narrow, but they’re likely to remain narrow. Overall, the Federal Reserve is managing a very successful course here.”