The overshooting of inflation has been followed by an overshooting of interest rates, the largest in nearly three decades since 1994, by a single 75 basis point increase, which has taken rates to levels last seen before the outbreak of the pandemic in March 2020.
The market is now divided on the “abnormal” rate rise: will the 75 basis point rise last?Will the recession actually play out?How will capital markets be affected?
The following are the views of various institutional analysts, which can be broadly divided into three categories.
The first group: the coolers
These analysts think the market can price in an aggressive rate hike, call for no panic, and say the Fed will not continue to be aggressive.
Mike Loewengart, managing director of investment strategy at Morgan Stanley’s E-Trade, says markets will be volatile, but investors should hang in there and not panic:
Two weeks ago, though, we might have thought a 75 basis point rise was out of the question, at least in the short term.But as inflation picked up, it became clear that the Fed needed to take a more aggressive approach.With us entering a bear market this week, the market may have priced in a bigger-than-expected rate hike.
But that does not mean that bigger rate rises will spook investors.Keep in mind that we may continue to see market volatility as we go through changing monetary policy and as markets digest the new normal.Don’t panic through the waves of volatility and stick to your investment strategy.
Barclays analyst Ajay Rajadhyaksha sees a return to 50 basis points in July:
75 basis points is a strong move, but given our economic development and housing situation, we believe the Fed will not need to announce another such move, and we think the Fed will raise rates by 50 basis points in July.
The second group: the austerians
Some analysts think the Fed’s aggressive approach won’t stop there, that the central bank really understands inflation is a big problem and that aggressive rate hikes are still on the way.
Max Gokhman, cio of AlphaTrAI, a financial investment firm, said further rate hikes are on the way:
First, there is clearly a frenzied mini-tug-of-war in which the bears are winning.I think the increase in the policy rate forecast to 3.4% from 1.9% at the last meeting signals a hawkish stance by the Fed.Not just because of the move itself, but because it shows that if the data continues to change, the Fed can quickly become more hawkish — that is, we could see them raising rates further at future meetings.
Kathy Jones, chief fixed income officer at the Schwab Center, said:
Markets are pricing in another 75 basis points hike at the July meeting and maybe a bit of a slowdown in September, but I think Powell, while he may have indicated that plan, I think he will also try to keep things more ‘open.
Anna Wong, chief economist at Bloomberg, said the Fed is starting to realize the seriousness of inflation and will signal more tightening:
The FOMC’s extraordinary rate rise comes amid signs of cooling in the economy and reflects the Central bank’s warnings about the recent rise in inflation expectations.Powell is determined not to repeat the mistakes of Arthur Burns, who led the Fed during the wage-price spiral of the 1970s.With the biggest rate hike at a single meeting since 1994 – and more tightening signals on the horizon – Bloomberg Economics argues that the Fed is already in a fast-catching position……
The latest SEP forecasts are more realistic than in the past, suggesting that officials have moved away from a “perfect deflation” worldview in which price pressures take care of themselves.Officials now seem to acknowledge that inflation is a real problem, and they are increasingly recognising and accepting the costs of tighter monetary policy.
The third group: worriers
On that basis, other analysts focused on the impact of aggressive rate rises, arguing that the US economy would slow and risk assets would come under attack before the Fed would even be forced to start cutting rates.
Frances Donald, global head of macro strategy at Manulife Asset Management, said the Fed’s aggressive rate hike will be followed by a rate cut next year:
The point today is that the Fed is catching up with the market’s thinking: raising rates early to push unemployment up, and then cutting rates in 2024.The Federal Reserve is happy to raise interest rates until the economy weakens, and then initiate rate cuts……
We expect the easing cycle to start in 2023, not 2024.
Seema Shah, chief Global strategist at Principal Global Investors, said the pain was coming:
The market is very worried about a 100 basis point rise and 75 basis points is fully priced in.So there is no negative impact from today’s decision……Once the [inflation] numbers start to rise at a faster pace, equities could fall again and credit markets will surely face more pain.Whichever way you look at it, the pain is today or tomorrow.
Michael Matousek, head trader at US Global Investors, said Investors could be “bagging their bags” ahead of a recession:
Investors will change their strategy from buying strong stocks to looking for falling stocks and trying to manage risk. We can no longer ride the Fed’s wind.Higher interest rates are necessary to regulate inflation. The difficulty is that the only way to reduce inflation is to slow down the economy. We know investors are likely to sell risky assets before the economy slows down.