Data dependent Fed to continue with its rate hike path

Key Highlights:

• US Federal Reserve decided to raise interest rate by 50 bps to a range between 4.25% - 4.50% and signaled plans to lift rates though spring.
• Central bank signaled that magnitude of the hikes may be smaller but may ultimately move to higher levels than anticipated.
• Federal Open Market Committee decided to continue with its balance sheet reduction as announced in May 2022.
• US Federal Reserve Chair Powell said no officials had projected rate cuts next year and that they weren’t likely to consider lowering interest rates until policy makers are confident inflation is moving down to the Fed’s 2% goal in a sustained fashion.

Economic Projections:

• US Federal Reserve in its economic projections revised lower its GDP growth forecast for 2023 to 0.5% compared to September estimate of 1.2% and even downgraded its growth outlook for 2024 to 1.6% compared to September projection of 1.7%
• Fed expects unemployment rate to rise to 4.6% in 2023 compared to September estimate of 4.4%
• Fed projects core inflation which is sitting at 5% in October to fall to 3.5% at the end of next year but is up from September estimate of 3.1%
• Median projection for Federal funds rate is 5.1% at the end of 2023 up from 4.6% projected in September and median projection is 4.1% at the end of 2024

Guidance on Inflation and Economic activity

• US Federal Reserve Chairman Jerome Powell said growth in consumer spending has slowed from last year’s rapid pace, in part reflecting lower real disposable income and tighter financial conditions and activity in the housing sector has weakened significantly, largely reflecting higher mortgage rates. Higher rates and slower output growth is weighing on business fixed investments
• The labor market continued to strengthen and is extremely tight. Unemployment rate is near 50 year low, job vacancies still high and wage growth has elevated. Employment rose by an average of 272,000 jobs per month over the last three months
• US Federal Reserve Chairman Jerome Powell said inflation remained well above longer run goal of 2%. The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases, but it will take substantially more evidence to give confidence that inflation is on a sustained downward path

Monetary Policy statements

• The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks
• The Committee seeks to achieve maximum employment and inflation rate of 2% over longer run. In support of these goals committee decided to raise target range for the federal funds rate to 4.25% to 4.50% and anticipates that ongoing increases in the target range will be appropriate
• In determining the pace of future increases, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments
• In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May
• In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals

View on Dollar Index and Rupee:

Dollar Index is likely to come down till 101 levels as long as its sustain below 106 level. Dollar will show weakness as US Fed slowed down its pace of rate hike and has downgraded its growth outlook sharply for 2023. We expect Fed funds rate to peak at 5% in the first quarter as it takes time for the full effects of those increases to ripple through economy. Further, we expect fed to start cutting down rates in fourth quarter. Moreover, Powell also said that Fed hadn’t made any decisions about upcoming meetings and that the outcome would depend on state of economy

Rupee is likely to appreciate back to 81.00 levels as long as it sustains below 83.30 levels amid weakness in dollar and as RBI raised its benchmark interest rate by 35bps and sounded hawkish over inflation outlook

Source: ICICIdirect Research

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