US Fed’s future moves “shrouded in mystery”

Yasmine Raso

Senior Journalist, Financial Newswire

28 July 2023

After a further 25-basis-point hike from the US Federal Reserve (Fed) at the July meeting brought the federal funds rate to its highest level in over 20 years, markets have been left guessing the committee’s next moves.

Principal Asset Management’s Chief Global Strategist, Seema Shah, said while the decision to raise the rate to 5.25 per cent to 5.5 per cent was widely anticipated by the market, they have been left in the dark on the Federal Open Market Committee’s future decisions.

“In recent weeks, the market has celebrated a drop in headline inflation to 3% and continued evidence of a resilient labor market,” she said.

“While Powell acknowledged the downside inflation surprise, he slightly downplayed its importance, noting that it is just one month’s data and that markets should not read too much into it.

“He also pointed out that the process of getting inflation down to 2% has a long way to go, potentially taking until 2025, which signals that policy will likely need to remain restrictive for some time.

“In addition, while Powell welcomed that the unemployment rate is unchanged from when the Fed started to raise rates last year, he also pointed out that they are looking for the labor demand/supply dynamics to come back into better balance.

“Historically, labor market conditions have tended to soften when monetary policy is tightened, and, as Powell pointed out, a weakening labor market remains the most likely outcome from here.”

With Principal Asset Management’s forecast for rates to peak at 5.25 per cent to 5.5 per cent, which is their current level, Shah also said that a strong economy, rising commodity prices and rapid labor market amid “waning inflation” sends mixed signals of an “inflation resurgence lurking around the corner”.

“Powell started 2023 as a lonely figure, believing a soft landing for the U.S. economy was possible,” she said.

“In the past month, however, many Wall Street analysts have capitulated to his view and, as Powell revealed today, Fed staff forecasts have also shifted from recession to soft landing.

“In our view, and despite those shifts, the ‘long and variable’ lags of monetary policy must surely mean that recession risk is still alive and elevated.”