The board of governors of the Federal Reserve System voted unanimously on 17 March to maintain the interest rate at 0.1%, confirming its dovish bias.
The move was echoed by its UK counterpart, the Monetary Policy Committee (MPC), when it announced it had also unanimously voted to keep rates at 0.1%.
The Federal Open Market Committee said: “Following a moderation in the pace of the recovery, indicators of economic activity and employment have turned up recently, although the sectors most adversely affected by the pandemic remain weak.
“Inflation continues to run below 2%. Overall financial conditions remain accommodative, in part reflecting the policy measures to support the economy and the flow of credit to US households and businesses.”
The FOMC added: “The ongoing public health crisis continues to weigh on economic activity, employment and inflation, and poses considerable risks to the economic outlook.”
Money tide is turning
Janus Henderson’s head of multi asset, Paul O’Connor, described the FOMC statement as a “reprieve”.
“As widely expected, the Fed’s new growth forecasts were a major uplift to December’s stale predictions, reflecting recent improvements in US macro momentum, the new administration’s fiscal stimulus and vaccine-boosted reopening trends. Real GDP forecasts of 6.5%, 3.3% and 2.2% for 2021, 2022 and 2023 and Core PCE forecasts of at 2.2%, 2.0% and 2.1% were typically quite close to consensus expectations.
“What was most interesting here was that, despite these forecasts and the Fed’s projected decline in the unemployment rate from over 6% today to 3.5% in 2023, the consensus view from Fed governors is that they expect to keep interest rates on hold throughout 2023.
“While bond markets can take comfort from the Fed delivering on its promise to go slowly with rate hikes, despite inflation creeping above the 2% target, the monetary tide is nevertheless turning.
“Whereas, back in December, only five of 18 Fed officials predicted higher rates in 2023, seven now expect a rate hike in that year and a third of the committee expects that more than one will be needed. Four participants now project hikes for 2022, compared to just one in December.”
Cautiously monitoring developments
Silvia Dall’Angelo, senior economist at the international business of Federated Hermes, commented that the “tone of the [MPC] meeting has remained cautious, in line with the stance adopted by the other major central banks over the last week”.
“The Bank of England is facing the same cross-currents: since its previous meeting in February, most developments – notably fresh rounds of fiscal stimulus domestically and abroad – have had positive implications for the economic outlook, but downside risks and uncertainty concerning the evolution of the pandemic are still prominent.
“The Bank of England is cautiously monitoring developments for now. An accommodative policy setting is still needed to support the incipient recovery. But there is uncertainty surrounding the existing degree of spare capacity and about relative dynamics in supply and demand going forward.”
Dall’Angelo added: “Which means that the Bank of England should be equally ready for its next move being further easing or the beginning of a tightening course.”
Equity markets have taken comfort
Rupert Thompson, chief investment officer at wealth management group Kingswood, said: “The Federal Reserve did its best yesterday to convince the markets that it still has every intention to do all it can to support the economic recovery and has no plan to tighten policy any time soon.
“The Fed revised up this year’s growth forecast sharply to 6.5% from 4.2% and also nudged up its projection for core inflation to 2.2% from 1.8%. Yet, it kept its very dovish guidance of late unchanged and the majority of the Fed continues to forecast no rate hike before 2024.
“Equity markets have taken comfort from the Fed’s soothing words with US equities closing higher and European markets also up this morning. Meanwhile, the dollar fell back slightly and US Treasury yields edged lower as markets scaled back their timetable for rate hikes a little, although they are still pricing in two rate hikes for 2023 unlike the Fed which is projecting none.”
Still unknowns
Bill Papadakis, macro strategist at Lombard Odier, says the FOMC outcome was “reassuring for risky asset markets”, but added that “the Fed has not answered all critical questions for markets”.
“The outlook upgrades were significant but not outsized. And while marginal inflation ‘overshoots’ may be tolerated, we do not know how far the Fed’s tolerance will extend. Finally, it is worth noting that while most participants expect an unchanged policy rate until 2024, the number of those expecting an earlier rate hike is rising (four by 2022, seven by 2023).
“In other words, this is not the ‘end of the game’. Our base case remains that a sharp recovery will eventually push the Fed to deliver its first interest rate hike by late-2023.”
What to do?
In terms of asset allocation impact, the cross asset solution team at Unigestion commented: “Our current dynamic allocation highlights that we should remain positive on growth and inflation-oriented assets, but these exposures have been reduced significantly reflecting the deteriorating risk/reward.”
This was based on three elements:
Macros: “Growth remains solid and inflation is on the rise. The longer-term picture is supportive for growth assets but also inflation assets.”
Market sentiment: “Sentiment is now very high for growth assets broadly, and this exuberance could lead to bursts of stress.”
Valuation: “Growth assets are expensive, while inflation assets have solidly repriced a reflation scenario.”
