Markets
Rate engine nears a pause signal
Summary
The rate hike was a unanimous decision of the Fed’s committee members and largely in line with market expectations. The next Fed meeting is on 13-14 June.
The US Federal Reserve (Fed) has delivered a 25 basis points (bps) policy rate hike, taking the federal funds rate to 5-5.25%. This is the Fed’s tenth consecutive rate hike since March last year. The battle against inflation has led to a whopping 500bps monetary policy tightening in the said span.
The rate hike was a unanimous decision of the Fed’s committee members and largely in line with market expectations. However, a dove—signalling an upcoming pause—is hovering. The next Fed meeting is on 13-14 June.
The noteworthy shift in Fed’s tone is comforting. For instance, the Fed has said, “Looking ahead, we will take a data-dependent approach in determining the extent to which additional policy firming may be appropriate." In comparison, in the March meeting, the Fed had noted, “The committee anticipates that some additional policy firming may be appropriate."
This suggests that this hike could be the last in the current tightening cycle, as US economic data and current macro picture indeed point towards a pivot. Thus, it is more likely than not that we may have reached a terminal rate.
“While it (Fed) does not rule out further tightening, it emphasizes the steps that have already been taken and the delays before their effects are felt. Ultimately, the softening of the statement resembles the communicative turnaround in June 2006, when, after numerous rate hikes, the rate also peaked at 5.25% and remained at that level for 15 months," said economists at Commerzbank AG in a note on 3 May.
Inflation, which has been the Fed’s unwavering focus point in the last one year, has started to finally ease. The US headline consumer price index (CPI) inflation moderated for the ninth consecutive month, coming in at 5% year-on-year in March, the lowest reading since May 2021. Adding to that, the long-term inflation expectations in the economy remain well-anchored.
The transmission of the Fed’s policy tightening so far has already started to play out. Increased lending rates and tighter credit conditions would impact aggregate demand and economic activity and consequently curb price pressures in the economy. But as the Fed acknowledged, “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation." It helps that commodity prices have softened in recent weeks and downward momentum may continue amid subdued global growth outlook.
While inflationary pressures are easing, US economic momentum is softening too. Most interest rate-sensitive sectors like housing are already starting to groan under the burden of a sharp rise in interest rates. As credit conditions continue to tighten, the spill-over to other sectors could materialize.
The recent banking sector turmoil in the US since March has resulted in higher credit costs and tighter lending conditions for households and businesses. According to the Fed, “These tighter credit conditions are likely to weigh on economic activity, hiring, and inflation." In short, this is what monetary tightening has been aiming to achieve.
Back home, Reserve Bank of India (RBI) hit the brakes on monetary tightening in April after six consecutive rate hikes since May last year. At the same time, RBI governor emphasised that the pause is for just that meeting and it is not a pivot while the central bank retained its “withdrawal of accommodation" stance. However, with domestic economic activity on a better footing and easing headline and core inflation, RBI may also be near the end of its rate hike cycle. A dovish tilt in Fed’s language, the bellwether in the current monetary tightening spree, makes this more compelling.
