US Fed signals pause in rate increases

Key Highlights:

• The US Federal Reserve decided to raise interest rate by 25 bps to a range between 5.0% and 5.25% but signaled that they might be done raising interest rates for now and amplified attention to credit and other economic risk
• Federal Open Market Committee also decided to continue with its balance sheet reduction as announced in May 2022
• US Federal Reserve Chair Jerome Powell pushed back market expectations that FOMC would cut rate this year by saying it would not be appropriate to cut rate this year

Guidance on inflation and economic activity:

• US Federal Reserve Chairman Jerome Powell said the economy has slowed significantly last year. Pace of economic growth in Q1 2023 continued to be modest, despite a pickup in consumer spending. Additionally, activity in the housing sector continued to weaken due to higher mortgage rates. Furthermore, higher interest rates and slower output growth is weighing on business fixed investments
• Despite the economic slowdown, the labour market remains very tight. Unemployment rate is near 50 year low even so there are some signs that supply and demand in labour market are coming back into better balance. Nominal wage growth has shown sign of easing and job vacancies have declined so far this year
• Inflation remained well above longer run goal of 2% but has moderated somewhat since middle of last year

Monetary Policy statements:

• The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks
• The Committee seeks to achieve maximum employment and inflation rate of 2% over the longer run. In support of these goals committee decided to raise target range for the federal funds rate to 5.0% to 5.25% and will closely monitor incoming information and assess the implications for monetary policy
• In determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, 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 along with 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:

• We expect dollar index to continue with its downward trend on anticipation that this would be the last rate hike and Fed to hit a pause button for a while, particularly due to lingering concerns over economic growth and a renewed banking crisis
• Moreover, yields are tumbling as market expects possible rate cut by the end of the year rather than just pause in rate increases. The cumulative effect of last year’s aggressive rate hike has been slowing the economy as most economic parameters like housing, Manufacturing and Consumer spending have started showing weakness. Moreover, economy is likely to slow even more as the year progresses as lagged effect of Fed aggressive rate hike are beginning to take their toll. Additionally, growth in wages and salaries has started slowing down comforting central bank. Furthermore, central bank noted that the strains that emerged in the banking sector in early March may result in even tighter credit conditions for households and businesses which in turn will weigh on economic activity, hiring, and inflation
• Dollar Index after making a high of 105.88 in March 2023 again started losing its steam and slipped back near 101 levels. Dollar Index is facing strong resistance near 103. As long as it sustains below this level, the downtrend may remain intact. We expect the Dollar index to eventually move towards psychological levels of 100
• US$INR has failed to breach 83 levels from past of couple of months. We still expect it to work as stiff resistance but now it will first face hurdles near 82.50 levels. As long as it sustains below it, the rupee is likely to appreciate till 81.0/80.80 levels in the coming month considering ongoing weakness in the dollar and softening of crude oil prices