THE pace of US interest rate hikes has clearly slowed.
With the US Federal Reserve (Fed) just increasing rates by 25 basis points (bps) following eight aggressive hikes, all are wondering when it will stop raising rates.
However, the timing for rate cuts will be a different matter as the fight against inflation is not over.
Currently, it is uncertain if one final hike of 25 bps is sufficient.
Meanwhile, Wall Street is trying to decide if the Fed will cut rates soon amidst warnings that these rate-cut bets could be wrong.
Would it be possible that by the time the US Federal Open Market Committee (FOMC) meets from May 2-3, the inflation rate in the United States, unlike in Europe, will have come down sufficiently for it to stop raising rates?
US prices rose 6% in February against the peak of 9.1% last June; although on a downtrend year-on-year, it remains high above the Fed target of 2%.
In a grand scheme of things, the Fed has delivered 475 bps of rate hikes within a year.
However, the ripple effects caused by steep borrowing costs may not be immediate; it will be around 12 to 18 months before we can see the full impact of these rate hikes. Thus, inflation may continue to be a problem.
The benchmark Fed funds rate (FFR) may reach its terminal state between now and May; from then on, Fed decisions will depend on incoming data.
The Fed might shift its focus on economic growth, which warrants it, at some point in the future, to take on an accommodative stance on monetary policy to keep interest rates low, said Bank Muamalat chief economist and head of social finance, Afzanizam Mohd Rashid.
Mixed picture
The direction of the US economy, while showing a mixed picture, may shift to a clearly weakening trend.
Currently, the low unemployment rate is still giving the impression that the economy is still holding up.
However, in line with earlier commitments to keep rates high for longer, there may be less of a rush to begin a series of rate cuts, unlike previous rate cycles, said former Inter-Pacific Securities head of research, Pong Teng Siew.
US banks are taking precautions following the recent banking crisis where a few banks saw their bond holdings diminish in value due to rising rates; the situation is contained at the moment but US banks are taking steps to stay liquid.
US discount window borrowings had surged to US$117bil (RM516bil) two weeks ago, compared with US$32bil (RM141bil) in the previous week, and surpassing the US$112bil (RM494bil) seen in the subprime crisis of 2007-08.
For now, the Fed is in a difficult situation – choosing between price and financial stability, which is no easy feat.
The March dot plot or outlook for the benchmark FFR shows that most FOMC members are in favour of pushing the FFR higher to between 5% and 5.25% (March 2023: 4.50% and 4.75%).
The US personal consumption expenditure inflation rate is still trending way above the target rate of 2% (January 2023: 5.4%).
At the very least, we can take comfort that the Fed will exercise caution in its inflation fight from now on, unlike in the second half of 2022, said Bank Islam Malaysia chief economist Firdaos Rosli.
The FOMC had acknowledged that recent developments involving bank failures are likely to result in tighter credit conditions for households and businesses.
Yet the data does not support a pivot at this juncture.
The distribution of individual dots on the Fed’s dot plot is skewed to the upside around the median dot for 2023 and 2024.
The hurdle is high for the median dots to move lower – more Fed members need to be convinced to move the median dot lower, than to move it higher.
The base case for OCBC Bank is one final rate hike of 25 bps in the current tightening cycle, which will bring the FFR target range to 5% to 5.25%, while it expects the easing cycle to start in early 2024, said OCBC Bank rates strategist Frances Cheung.
The possibility remains that rates could end the year higher than expected, should the inflation rate remain stubbornly high.
Based on the latest dot plot, seven out of 18 Fed officials surveyed are projecting for more than one 25 bps hike.
Fed chair J Powell had also indicated that rate cuts are not within its base case for this year, said RAM Rating Services head, economic research, and senior economist, Woon Khai Jhek.
The timing of US rate cuts is crucial.
Optimistic markets
Are markets too optimistic to price in large Fed rate cuts in the second half?
Core inflation remains stubbornly sticky and the Fed has no space to ease rates despite the banking turmoil.
Some see that there is no panic in such a situation where the Fed is caught between managing the banking crisis and having to still fight inflation.
To maintain stability while continuing to bring down inflation, there is the separation of duties between the Treasury and Fed.
The Treasury will have to step up to maintain financial stability; the Fed will broaden its liquidity facilities to support the banking system but use its interest rate policy to control inflation, said Maybank Investment Banking group regional co-head, macro research, Chua Hak Bin.
While markets jitters may linger for a while on these rate uncertainties, there is some hope for a rate cut quite soon.
Yap Leng Kuen is a former StarBiz editor. The views expressed here are the writer’s own.
