TPLC - U.S. Fed Hikes Policy Rate By 25 Basis Points Cautions On Outlook
2023-05-04 12:00:00 ET
Summary
- What are bond markets telling us about future Fed policy?
- How does the Fed navigate the numerous crosscurrents in the financial markets and economy?
- What's the outlook on the US dollar?
The U.S. Federal Reserve delivers another 25-basis point rate increase and hinted at a more cautious approach to further rate hikes. Anthony Okolie speaks with Hafiz Noordin, Portfolio Manager at TD Asset Management, about the Fed's decision and its commitment to bringing down inflation.
Transcript
Anthony Okolie: Hafiz, the Fed hiked rates 25 basis points. This was pretty much expected. But they also hinted at a pause in further rate hikes. Did anything stand out for you today?
Hafiz Noordin: Yeah, overall, it was fairly in line, as you indicated. And the statement itself leaned a little bit more dovish. Even though we got that 25-basis point hike, there was an omission around the language for future rate hikes. And what the Fed did is they moderated that language to essentially be a little bit more conditional on future data. But I would say that Chair Powell in his press conference did lean a little bit more hawkish to balance that out, focusing on inflation being high, and that need to keep inflation down was quite important to their mandate. So I think overall, a fairly balanced statement and really indicates the data dependence going forward.
Anthony Okolie: Okay so given that balanced statement, what has been the market reaction? Specifically, what are US bond yields telling us about further interest rate policy?
Hafiz Noordin: Well, bond yields were not too volatile today, I would say, which is kind of a good thing in that what the market was looking for was delivered. Looking ahead beyond this hike, there's not a lot that the market is expecting to happen in June, July. But getting towards September is when the market is still expecting the first rate cut, and then beyond that, another two rate cuts by the end of the year. And so that's still in line with where we were before the meeting. The market's still expecting inflation to moderate and growth to come down. And that would cause the Fed to have to start cutting in September.
Anthony Okolie: And in terms of those Fed cuts, is that too optimistic in your view, given this balanced statement?
Hafiz Noordin: Well, there's definitely two-sided risks to it. There isn't just one sort of base case that we're going towards that path of lower inflation and lower growth. There's definitely risks to that. Liquidity has also been very poor in the Treasury market. So it's hard to glean the right signals right now.
But I definitely say there is still that scenario that, as the data comes in, if inflation and wages are still firmer than what is expected by the market, we could see no cuts for the rest of the year. But I think if we do continue to see inflation coming down and if we do see core inflation coming down, and particularly we see the labor market starting to get a little weaker, I think that would vindicate the market's view of rate cuts coming, to the extent that we're still in a restrictive territory for the Fed policy rate. We're going from very restrictive to still somewhat restrictive.
Anthony Okolie: And you mentioned inflation. The Fed has said that inflation is still a primary focus. But they've also acknowledged other headwinds, the banking crisis for one, the weakening economic growth. But the job market, as you mentioned, still remains pretty resilient. How does the Fed navigate all of these crosscurrents?
Hafiz Noordin: Well, they have to have a really good balance between the hard data, which helps to show a little bit of the rear-view mirror, what's been happening recently in terms of economic data around labor, around consumption, around business sentiment. But they also have to look at forward-looking indicators around all parts of the economy, really to assess what they said in the statement, which is what is the cumulative leg or cumulatively of monetary policy tightening doing to the economy going forward. They also have to monitor how banks have been tightening credit conditions and to what extent is that reducing economic growth.
They need to look at those forward-looking indicators because they know that even if they start cutting now, it takes many quarters for that to feed into the market. So they do need to be proactive, not stay too hawkish for too long, with the risk being that they would lead the economy to a deeper recession than what they're expecting.
Anthony Okolie: And when you talk about those four leading indicators, what do you see as some of the key risks to the Fed's outlook going forward?
Hafiz Noordin: Well, one of the key risks for sure is around inflation. They are kind of expecting this disinflationary process to continue. The market itself is priced for inflation to moderate to the 3% to 4% range by the end of the year and getting more towards 2% over the next couple of years. That's definitely the key risk on the hawkish side that would keep the central bank on hold for a longer time or perhaps even need to do a new round of hiking. So we can't count that scenario out.
But I think the other key scenario is one I started to allude to, which is that there's definitely the policy mistake on the other side, where they stay on hold for too long and cause more of a crash in the economy because borrowing rates are very high. And if they're too focused on backward-looking data for inflation that looks high, they may miss the fact that all of the tightening that's been done is already doing the job. And so they have to be careful not to over-tighten from that sense.
Anthony Okolie: Okay, I want to talk about the US dollar because it has been on a bit of a downtrend leading up to this Fed decision. Where do you see the US dollar going in the future, particularly with them signaling that there could be a pause in future rate hikes?
Hafiz Noordin: Yeah, well, all else equal, that does indicate that the US dollar should stay flat to weaker from here because you do have the Fed pausing. But other parts of the global economy, you have the European Central Bank still hiking. They're still in this 25- versus 50-basis point debate. So they're still at that stage of the hiking cycle. And then you have the Bank of Japan, for instance, still at the very early stages of monetary policy tightening. And so what that could mean is that you see other currencies appreciate more versus the US dollar. And even from a growth perspective, if we start to see all of the tightening hit earlier in the US but in other parts of the world, credit conditions are not as tight, that would mean that US growth should underperform versus global, ex US growth.
So all of that does lead to the US dollar likely being a little bit weaker from here. But we should remember that the US dollar is already down about 10% from its peak from kind of Q3, Q4 of last year. And that means that from here, a lot of the easy money has been made in terms of being short US dollar. And I think right now, there's still a bit more resilience I think near-term. But the broader theme is still that the US dollar likely should weaken over the medium term.
Anthony Okolie: Hafiz, thank you very much for your time.
Hafiz Noordin: Thanks very much.
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U.S. Fed Hikes Policy Rate By 25 Basis Points, Cautions On Outlook