The Fed and the Markets

The Fed has hiked the base rate by 50 basis points, taking the Fed Funds Rate to 4.25% to 4.50%. The hike of 50 basis points is by no means a small hike, but some relief could be had from the fact that it is smaller compared to the earlier rate hikes. That would also mean that in response to better inflation numbers the policy rates may be hiked again but in still smaller ounces.

The Fed policy is not just Fed action on the rates but also the Fed communication. While the rate action has been on expected lines the Fed communication still indicates a position of non-negotiability when it comes to the inflation containment objective. To those who have fears about the adverse impact on growth, the Fed says, “without price stability, the economy doesn’t work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labour market conditions that benefit all.”

As of Nov 22, the 12-month average inflation was 7.10%, and core inflation was at 6%, both of which are well above the target inflation rate of 2%. Current indications are that inflation is coming down but there is need for further data supporting this inference to have greater confidence. Projections put the expected inflation levels to be 3.1% in 2023, 2.5% in 2024, and 2.1% in 2025. But upside risks remain more potent. The projection on the likely peak Fed Funds Rate is placed it at 5.10%, higher than earlier projections. This looks quite likely, going by the distance to be travelled to reach the 2% mark.

Labour market remains strong while consumer spending is slower indicating falling real disposable incomes in the face of inflation and hard money conditions. Therefore, further tightening can be expected unless the inflation numbers dip significantly. Both the money market yields, and the long end of the curve will remain range-bound in the immediate term. Again, much would depend on the data points and their consistency. One turkey is pardoned at every Thanksgiving Day.

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