US stocks fell slightly yesterday and ended their three-day rally after the Fed June meeting minutes showed that the US central bank is looking to hike rates even further.
At the June meeting, the Fed paused its rate hikes after ten consecutive hikes.
The Fed embarked on its rate tightening cycle in March 2022 and raised its policy rates by 25 basis points – ending the zero-bound interest rates.
It graduated to a 50-basis point rate hike at the next meeting. Thereafter the US central bank raised rates by 75 basis points at four consecutive meetings before lowering the pace to 50 basis points in December.
This year, the Fed has raised rates thrice by 25 basis points lifting the interest rates to multi-year highs.
Fed meeting minutes: Key takeaways
The minutes said, “Several participants mentioned that credit conditions had not appeared to have tightened significantly beyond what would be expected in response to the monetary policy actions taken since early last year.”
They added, “Some participants judged that it was still too early to assess with confidence the eventual effects of tighter bank credit conditions on economic activity and noted that it would be important to monitor closely the potential effects of banking-sector developments on credit conditions and economic activity.”
Fed members on future rate hikes
The Fed’s June dot plot showed another 50-basis point rate hike in 2023. The minutes revealed that only two of the 18 members see at least a 25-basis point hike in 2023.
The minutes said, “The participants favoring a 25-basis point increase noted that the labor market remained very tight, momentum in economic activity had been stronger than earlier anticipated, and there were few clear signs that inflation was on a path to return to the Committee’s 2 percent objective over time.”
The minutes added, “In discussing the policy outlook, all participants continued to anticipate that, with inflation still well above the Committee’s 2 percent goal and the labor market remaining very tight, maintaining a restrictive stance for monetary policy would be appropriate to achieve the Committee’s objectives.”
US inflation has fallen
Notably, while there have been wide-ranging layoffs at US tech companies, the hiring activity elsewhere has been quite robust. The nonfarm payroll has averaged 314,000 per month in the first five months of the year – which is higher than historical averages.
US inflation has also come down gradually and the annualized CPI was 4% in May – the lowest since March 2021 and less than half of the 9.1% that it peaked at in June 2022. Since that month however the annualized CPI has fallen in every month.
The minutes said, “Many [Fed officials] also noted that, after rapidly tightening the stance of monetary policy last year, the Committee had slowed the pace of tightening and that a further moderation in the pace of policy firming was appropriate in order to provide additional time to observe the effects of cumulative tightening and assess their implications for policy.”
Powell did not rule out consecutive rate hikes
Speaking at a monetary policy session in Sintra, Portugal, Powell said, “If you look at the data over the last quarter, what you see is stronger than expected growth, a tighter than expected labor market and higher than expected inflation.”
He added, “That tells us that although policy is restrictive, it may not be restrictive enough and it has not been restrictive for long enough.”
Powell said that he believes more monetary policy restriction is needed to tame inflation.
He said that Fed hasn’t yet decided on the trajectory and added “I wouldn’t take moving at consecutive meetings off the table at all.”
He repeated his previous stance that the strong labor market is aiding inflation.
Powell said, “Labor costs are really the biggest factor in most parts of that sector.” He added, “We need to see a better alignment of supply and demand in the labor market and see some more softening in labor market conditions so that inflationary pressures in that sector can also begin to subside.”
Fed sees a recession as a likely scenario
Meanwhile, Powell has said on multiple occasions that while Fed’s rate hikes might lead the US economy into a recession – its not an economic outcome that it is deliberately pushing on.
The June meeting minutes said, “The economic forecast prepared by the staff for the June FOMC meeting continued to assume that the effects of the expected further tightening in bank credit conditions, amid already tight financial conditions, would lead to a mild recession starting later this year, followed by a moderately paced recovery.”
The minutes however added, “Desk survey respondents still saw a recession occurring in the near term as quite likely, but the expected timing was again pushed later, as economic data pointed to the continued resilience of economic activity. Overall, respondents generally continued to expect that any downturn would be neither deep nor prolonged.”
US stocks soared in the first half of 2023
All said, despite the Fed’s rate hikes and mounting recession fears, US stocks rallied handsomely in the first half of 2023. The Nasdaq Composite rose 31.7% and had its best first-half performance in four decades.
The S&P 500 also rose 15.9% and had its best first-half performance since 2019.
US stocks crashed last year with Nasdaq tumbling over 33%. Even after the recent rally, the Nasdaq and S&P 500 are below their all-time highs.
While the rally in AI stocks helped propel US markets higher, expectations of a dovish Fed have also supported the uptrend.
Markets meanwhile are now bracing for more rate hikes in 2023. In a client note, Quincy Krosby, chief global strategist at LPL Financial said, “Even with their respective differences both sides of the FOMC view higher rates as likely in order to quell inflationary pressures and restore price stability.”
The CME FedWatch tool shows that traders are now putting an 89.0% probability of a 25-basis point rate hike at the Fed’s July meeting, which is 3.1 percentage points higher than the previous day.
The majority of traders meanwhile believe that the Fed would cut rates later this year and only 3.3% of the traders bet that rates would be at similar or higher levels by the end of this year. The remaining see rates falling below the current range of 5.0%-5.25%.
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