The Federal Reserve left interest rates unchanged on Wednesday following its two-day policy meeting, keeping rates at the 3.75%-4% range, in line with market expectations. However, the Fed hinted that it may slow the pace of rate hikes going forward as inflation shows signs of cooling.
Fed Signals Slower Rate Hike Path Ahead
In its statement, the Fed removed language about interest rates needing to rise to “restrictive” levels, an early sign the central bank could stop raising rates soon. While the Fed said it is “highly attentive” to inflation risks, it added that policymakers will take into account the “cumulative tightening of monetary policy” and the lags with which policy affects economic activity and inflation.
This shift in language indicates the Fed is ready to start slowing its aggressive interest rate hikes as inflation comes under control. After four consecutive 0.75 percentage point rate hikes, markets increasingly expect a smaller 0.5 point increase at the next meeting.
Inflation Pressures Continue Easing
The Fed’s slight policy pivot comes as inflationary pressures continue showing signs of easing globally and in the U.S.
Consumer price growth in China turned negative in November for the first time in over two years, with factory gate prices falling further. This disinflationary trend from China could have global ripple effects in coming months.
In the U.S., recent data showed wholesale inflation falling more than expected in November to 7.4% annually. Additionally, U.S. consumer price growth slowed to 7.1% annually, the lowest since December 2021 and below forecasts.
|U.S. Inflation Data
|Consumer Price Index (CPI)
|Producer Price Index (PPI)
These improving inflation trends increase the likelihood of smaller Fed rate hikes ahead rather than ongoing 0.75 point increases. Markets now expect rates to peak under 5% in early 2023, rather than above 5% as previously forecasted.
Markets Rally On Prospect Of Less Aggressive Fed
Global stocks rallied sharply as markets cheered the prospect of the Fed taking its foot off the gas pedal after 10 consecutive rate hikes in 2022.
In the U.S., the S&P 500 jumped 3.1% to its highest level since September, while the tech-heavy Nasdaq Composite surged 4.4%. Asian equities also posted strong gains, with Hong Kong’s Hang Seng Index adding over 3% and Japan’s Nikkei rising nearly 2%.
The U.S. dollar pulled back from recent highs following the Fed decision, as expectations for less aggressive tightening dented demand for the greenback. Meanwhile benchmark 10-year Treasury yields declined nearly 10 basis points toward 3.42%, reflecting easing rate hike bets.
Fed Remains Vigilant On Bringing Down Inflation
However, the Fed statement reiterated that ongoing rate increases will still be appropriate to restore price stability, cautioning that policy will need to be restrictive for “some time”. The central bank said it will continue closely monitoring the data and is “strongly committed” to bringing inflation back down to its 2% target.
Fed Chair Jerome Powell reinforced this hawkish messaging in his press conference, saying they still have “some ways to go” before stopping rate hikes, possibly above the 5% mark forecasted by policymakers in September.
While the Fed is poised to slow the pace of tightening, it remains focused on controlling inflation pressures and is not on the verge of a broader policy pivot just yet. But the days of jumbo 0.75 point rate hikes in 2023 look to be over.
So in summary, while the Fed kept rates unchanged today, it set the stage for slower interest rate hikes ahead – welcome news for equity markets. But inflation risks still remain, meaning further rate increases are likely on the agenda in early 2023 before peaking.
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