News & Analysis

The Federal Reserve today hiked the Fed funds target range by 25bps to 5.25-5.5%, its highest level in 22-years.

Given the unanimity of the decision amongst FOMC participants, and the fact such an outcome was widely expected by economists and markets after the June pause, news of the hike had little bearing on markets. Nor did the accompanying rate statement, which featured very few edits from the June edition. The only notable change in the language occurred in how the Fed views current economic conditions, with robust growth now framed in the past tense, suggesting that the economy is expected to cool from hereon in.

The dovish impact this had was largely offset by the retention of more hawkish language from June.

The Fed still views inflation as “elevated”, despite the dramatic deceleration in headline and core measures in June, while a more patient stance on the development of data is unchanged. The lack of fireworks in today’s rate statement came as no surprise as policymakers ultimately want to keep the door open for a further rate hike in Q4 in order to keep financial conditions tight as inflation pressures moderate. While the Fed did not formally acknowledge this as the last hike of this cycle for this reason, we continue to believe that rates are currently at their terminal level.

Powell de-emphasises inflation data, stressing the need for more labour market slack and below potential growth

After a rate statement that could have been accurately predicted in advance, the question for markets was how Powell would double down on the retained hawkish message from June despite a likely bombardment of questioning around the latest inflation report, which in isolation could have supported another pause in the hiking cycle. Here, Chair Powell downplayed the importance of the June CPI data, labelling it as “welcome, but only one report”, while stressing that FOMC members would need to see further rebalancing in supply and demand dynamics in the labour market and for growth to start trending below potential before they can take solace that monetary policy is sufficiently restrictive. In doing so, and stressing that the recent data has “broadly met expectations”, Powell suggested that Committee members remain committed to their June dot plot, which signals one further rate hike this year as the median outcome. This led to a much less dovish reaction in markets to today’s meeting relative to June’s. However, our view on the Fed’s dot plot remains unchanged from the June meeting. That is, we deem the Fed’s implied guidance of one further hike as merely a signalling mechanism aimed at keeping financial conditions relatively tight as inflation pressures cool instead of an accurate forecast of rates.

With US economic activity remaining robust and job gains cooling but only towards a more healthy growth rate, we think the openness of the Fed towards further policy tightening will keep markets pricing a tail risk that the hiking cycle is extended.

This should keep the dollar well supported at current levels over the summer period as we don’t expect US growth conditions to cool to below the Fed’s estimated level of potential of 1.7-2% until the end of Q3. While this suggests that another rate hike could be incoming at September’s meeting, we think continued improvement in the data in the interim will warrant another hawkish pause before officials publicly acknowledge the end of the hiking cycle in November. Nonetheless, tomorrow’s release of the advanced Q2 GDP report and Friday’s June personal spending data will provide the first tests to this thesis.

A job well done: market pricing of a potential rate hike in the next two meetings remains broadly unchanged following today’s decision



Simon Harvey, Head of FX Analysis


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