- Policymakers voted unanimously to increase rates by a quarter of a percentage point in the latest Federal Open Market Committee meeting (FOMC) this week.
- The interest rate now stands at a 16-year high of 5-5.25%1, despite recent turmoil in the banking sector.
- Fed Chair Jerome Powell has not ruled out raising rates again, subject to future economic data, but hinted the central bank has done enough for now in its campaign to bring down inflation.
The Fed’s decision to hike rates comes just weeks after the collapse of three major US banks – Silicon Valley Bank (SVB), Signature, and First Republic – as well as European giant Credit Suisse.
Despite expectations that the latest increase might now signal a pause, Powell’s accompanying statements left the window open to the possibility of further rate hikes if conditions made it necessary.
Here the question of labour markets remains key (see Figure 1) – particularly given how tight they have been year-to-date. Against this backdrop, Powell said the decision to pause rate rises hadn’t been made but emphasized that policy action in June’s FOMC would be more data-dependent than ever.
“We think this is the appropriate stance,” said Susan Hill, Senior Portfolio Manager at Federated Hermes Limited. “Until the economic impact of tighter credit conditions resulting from the March banking sector stresses is better understood, taking a breather is warranted.”
Until the economic impact of tighter credit conditions resulting from the March banking sector stresses is better understood, taking a breather is warranted.
On the question of banking sector stresses, James Rutherford, Head of European Equities at Federated Hermes Limited, highlighted the prospect of negative sentiment becoming self-fulfilling.
“There’s a risk of entering a self-fulfilling cycle – leading to lower stock prices, higher funding costs, and deposit flight, which could result in mark-to-market losses on banks’ held-to-maturity assets,” he said. “These losses have been driven by the Fed’s tightening cycle driving up rates and pushing down the prices of government bonds.”
Figure 1: The percentage change in US employment, from February 2020 to February 2023
Source: US Bureau of Labour Statistics, as at February 2023.
Meanwhile, in a move that mirrored the Federal Reserve’s rate hike, the European Central Bank (ECB) has announced a hike of a quarter of a percentage point2, as it works towards its target of 2% inflation.
For Silvia Dall’Angelo, Senior Economist at Federated Hermes Limited, this latest hike could be a sign that Europe, too, is nearing the end of its rate-tightening cycle .
“This outcome looks like a reasonable compromise given recent data showing how inflation and credit developments are pulling in opposite directions,” said Dall’Angelo. “Moreover, as the current hiking cycle has been the fastest in the ECB’s history and monetary policy operates with long lags, the case for slowing down the pace of tightening at today’s meeting was strong: The ECB is now in a better position to assess the impact on the financial system and the real economy from the tightening cycle so far. While it’s probably not done, the peak rate is close.”
For further insights on Europe, please watch our video with Portfolio Manager Chi Chan, and read our latest take note here.
1 The Financial Times, as at 3 May 2023.
2 The Financial Times, as at 4 May 2023.