The Fed faces a whipsawing dilemma as we approach the next meeting on 3rd May. Can they raise rates considering recent banking problems and impending credit issues? Can they afford not to with inflation still running so far above target?
The perceived banking crisis in the weeks preceding the last meeting on the 22nd March saw yields seesawing and the market pricing in no change at one point.
Indeed, the minutes from that meeting showed that some Fed members had discussed pausing but, with a degree of calm returning to the markets in the days prior to the decision, the overriding need to fight inflation prevailed and as the Fed took advantage of the opportunity to continue raising rates.
Conversely, the overall sentiment in the run up to the upcoming Fed rate decision on the 3rd May has been more subdued when compared to the volatility we saw in March. Medium-term yields have moved back up, implying a more stable interest rate environment going forward, and equity markets have moved up from the lows seen in mid-March.
Earnings results from JPMorgan, Citibank, and Wells Fargo have indicated that the big systemic banks are in good shape, calming markets further.
As such, we expect curbing inflation to remain the Fed’s priority with a 25bp rise most likely.
The market is now pricing in an 88% probability that the Fed will raise rates by 25bp at this meeting. The inflation picture is improving but is still a long way away from where it needs to be, and the job market remains resilient.
Chairman Powell has stated that he sees room for one more rate rise, and other Fed speakers have varied between one and two more increases. Projections now suggest that any recession will be shorter and shallower than previously feared.
Rate cuts for this year are still being priced in by the market with the projected year-end Fed rate lower than where we are now. However, Fed speakers have been quick to dismiss the idea that they will cut rates in 2023. This poses a threat to the equity markets, where much of the bounce has been based on a lower interest rate environment going forward.
Emerging markets are also heavily reliant on establishing that we are close to the peak in USD interest rates. Although many are facing challenges of their own, some due to the USD squeeze, some not – a move away from the rate tightening cycle would clearly help the Global South.
