- The US Federal Reserve refuses to declare victory on inflation just yet.
- Fed Chair Powell's rejection of rate cuts in 2023 is set to trigger additional US Dollar strength, and weakness in stocks.
- Bond markets will eventually be vindicated, the key to the next moves is on the data.
A hawkish downshift – the United States Federal Reserve has raised rates by 25 bps, lower than 50 in December 2022 and 75 beforehand. However, it is pushing back against declaring victory against inflation. Moreover, Fed Chair Jerome Powell does not like market pricing of rate cuts in 2023.
I side with markets – which expect the Fed to slash borrowing costs later this year. However, investors jump forward and the Fed wants evidence. Incoming data will likely show weakness in the labor market and inflation, and that would change the mood in Washington.
However, at this point in time, markets cannot fight the Fed – and neither should traders. There are several valid points. The most sticky part of inflation is related to wages, and these are still rising. The "non-shelter core services" factor needs rate hikes to come down and cannot fall on its own.
Another argument is history, but that is a weaker one. In the past, central banks celebrated victory against rising inflation too soon, triggering another nasty wave. However, things move much faster now than in the 1970s – on the way and on the way down.
The world's most powerful central bank wants a risk-off mood, and it will get it in the short term. But if data continues weakening – including in the cooling labor market – the Fed will have no choice. It is essential to note that in late 2021, the bank forecast rates to reach 0.90% by end of 2022. They reached 4.50%.
Also now, the Fed's hawkishness is based on the data it has and on the will to ensure inflation is coming down and the economy is cooling down. But if these things are realized, it could declare victory.
In the short term, I a dark mood, but then a recovery from stocks once the data is weak – pointing to looser policy.
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