Unveiling the Federal Reserve's Hawkish Turn: Impact on Rates, Markets, and Inflation
The Federal Reserve's decision to pause rate hikes had already been anticipated by the market, but the unexpected hawkish tone has significant implications. It suggests that interest rates will not only stay elevated for the remainder of this year but well into 2024. This shift in the Fed's monetary policy sent shockwaves throughout the financial markets.
In the press conference that took place on September 20, 2023, Federal Reserve Chair Jerome Powell stated "Today we decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings. Looking ahead, we are in a position to proceed carefully in determining the extent of additional policy firming that may be appropriate."
What to Expect
The Fed is now expected to raise rates once more this year, with an increment of ¼%. This would bring the Fed funds rate to a range of 5.5% to 5.75%. The updated projections signal the Fed's intention to maintain its terminal rate above 5% for the entirety of 2024.
Perhaps the most significant surprise was the Fed's decision to reduce the number of anticipated rate cuts next year from four to just two. Consequently, both the general public and businesses should prepare for continued high borrowing costs, remaining well above 5%, throughout the upcoming year. This unexpected adjustment took some time for the financial markets to digest, as evidenced by widespread reactions.
What Is the Effect
U.S. equities experienced a significant downturn, with the S&P 500 declining by 1.6%, the NASDAQ composite dropping 1.8%, and the Dow Jones industrial average falling by 1.1%. These market fluctuations signify a noticeable shift and emphasize the profound influence of the Federal Reserve's revised approach to interest rates.
In the realm of U.S. bonds, there was a substantial surge observed this week, particularly in the 30-year government bond, which recorded an impressive gain of 3.62%, elevating the yield to 4.578%. Concurrently, the yield on the 10-year U.S. bond has risen to 4.49%.
What About Inflation
Inflation has shown signs of easing since the middle of the previous year, and the expectations for longer-term inflation appear to be firmly secured. However, it continues to remain well above our longer-run goal of 2 percent. Jerome Powell emphasizes that the process of getting inflation sustainably down to 2 percent has a long way to go. The SEP's median forecast for total PCE inflation indicates a rate of 3.3 percent for the current year, followed by a decrease to 2.5 percent in the next year, ultimately converging to 2 percent by 2026.
In conclusion, the recent decisions and statements from the Federal Reserve have reshaped the financial landscape and sparked significant reactions across various sectors. The anticipated rate hike pause, combined with an unexpected hawkish tone, has laid the groundwork for interest rates to remain elevated not only for the remainder of this year but also well into 2024.