Powell follows Fed rate hike with a dovish outlook

In a unanimous decision today, the US Federal Reserve (Fed) raised rates by 25 basis points. That was followed by a largely dovish press conference by Fed Chair Jay Powell.

While the Fed obviously wants to leave the door open to more rate hikes in an attempt to keep a lid on easing financial conditions, Powell was clear that the Fed is nearing the end of tightening. He noted that the Fed has raised the fed funds rate by 525 basis points since March 2022, and was emphatic that monetary policy is now restrictive.

Powell also said that if the US sees inflation coming down credibly, sustainably, then the Fed doesn’t need to be at a restrictive monetary policy level anymore. He said that while inflation is unlikely to get to 2% until 2025, the Fed could stop raising rates long before then — and could start cutting.

How have markets reacted??

Markets flip-flopped in the immediate wake of the news, with the statement perceived as hawkish and the press conference perceived as more dovish (despite a few Powell statements that caused stocks to momentarily sour).

What is our outlook on the situation??

?Looking ahead, we think it likely that the Fed is at or near the end of the tightening cycle and we expect policy rates to be reduced throughout 2024, though today’s policy statement weakens that conviction. We expect the US yield curve to begin steepening over the coming months and for that to continue throughout 2024. In the early stages of steepening, we suspect that yields could fall along the curve, but would expect the effect of duration to give better returns at the longer end of the curve.

We feel that equity markets have already anticipated the move to Fed easing, and we wouldn’t be surprised to see a surrender of recent gains over the coming months before indices eventually move higher. We expect the dollar to weaken over the next 12 months.

Given that the Fed is still data dependent, we anticipate volatility in the near term, but we also expect an increase in global risk appetite as markets continue to positively re-price recession risks and ultimately look forward to, and discount, an economic recovery.

What are the risks to our view???

The risk is that the path of inflation moderation going forward may not be satisfactory enough for the Fed to end the hiking cycle. A prolonged tightening cycle would increase the potential for financial accidents as well as recession risks and prolong the time before an economic recovery could start. This environment would favor defensive investment positioning, in our view.

Important information

NA3025839

Header image: Xiongmao / Adobe Stock

Not a Deposit - Not FDIC Insured - Not Guaranteed by the Bank - May Lose Value - Not Insured by any Federal Government Agency

Invesco Distributors, Inc.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

All investing involves risk, including the risk of loss.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

A basis point is one hundredth of a percentage point.

Tightening monetary policy includes actions by a central bank to curb inflation.

The federal funds rate, or fed funds rate, is the rate at which banks lend balances to each other overnight.

A policy rate is the rate that is used by a central bank to implement or signal its monetary policy stance.

The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity.

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates. Duration is expressed as a number of years.

The opinions referenced above are those of the author as of July 26, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.