U.S. Fed Makes History With Second Consecutive Rate Hike

FOMC raises short-term interest rates in the U.S. by 75 bps, market shrugs off decision as dovish after Powell speech.

The Federal Open Market Committee (part of the U.S. Federal Reserve) has unanimously raised interest rates by 75 bps, reaching 2.5%. The meeting announcement pointed to a deteriorating economy as the reason behind the move, stating that “recent indicators of spending and production have softened”. The Fed believes the job market remains tight and inflation elevated, which leaves the door open to a swift return to a more hawkish approach, rising rates even further, and causing the markets to tumble.

While the markets initially fell following the FOMC meeting, Fed Chairman Jerome Powell reassured the market that quantitative tapering was on schedule and “as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases”. With the Fed Chair’s seemingly dovish statement, markets rallied, with indexes reaching new highs and volatility in both bonds and equities tanking, as measured by the ICE BofAML MOVE Index (MOVE) and the CBOE Volatility Index (VIX).

Higher interest rates usually mean higher opportunity costs, which tends to drive asset prices down, as treasury bills’ yields rise. But this hasn’t happened this time, as Chair Powell dismissed comments, following the Fed meeting, that the U.S. might be heading to a recession right now, giving investors a sigh of relief and optimism.

Though the dot-plot – which shows how every Fed president forecasts the funds rate in the next few years – points to an interest rate of around 3.5% by 2023, some investors are still pricing in rate cuts by Q1 2023. The continued expectation of rate cuts was fuelled by the chairman’s statement that it is “likely appropriate to slow increases (of interest rates) at some point”.

Jerome Powell stated that the committee was now “data dependent” on further rate hikes, dropping the forward guidance for now. Investors seem to have taken it as a clear message, as the Nasdaq achieved its biggest rally since November 2020 and the U.S. dollar fell despite the rate hike, which tends to make the currency rise. Already analysts, including from JP Morgan, are predicting the Fed will return to smaller rate hikes at the next Fed meeting.

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