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On Wednesday, all focus of the market was on the Fed’s policy decision, where the Fed was expected to hold the rate with an indication of at least another hike in the rest of 2023. Overall, Wall Street Futures, Gold slumped, and USD jumped as the Fed’s statement/SEP/dot-plots indicated another +25 bps rate hike in the rest of 2023 and a -50 bps rate cut in 2024 against June projection of -100 bps; the Fed also kept core PCE inflation projection for 2024 at +2.6%, unchanged from June projections, but higher than market expectations. In his post-meeting presser/Q&A, Fed Chair Powell also did not try to sound dovish to keep Wall Street in a jubilant mood. Overall, the Fed’s stance may be termed as hawkish hold, more than the market expected. Subsequently, there was some risk aversion move soon after the Fed’s higher-for-longer stance in 2024.
On Wednesday, the U.S. Fed held all primary policy rates as unanimously expected; i.e. the target range for the Federal Fund's Rate (FFR-interbank rate) at +5.38% (5.25%-5.50%); primary credit rate (repo rate) at +5.50%; IOER (reverse repo rate) at +5.40%; overnight repurchase agreement rate (RP) at +5.50% and RRP (Overnight Reverse Repurchase Agreement Rate) at +5.30%, keeping U.S. borrowing costs to the highest level since January 2001 (22-years).
On Wednesday, the U.S. Fed kept the target range for the Federal Funds Rate (FFR) at a 22-year high of 5.25%-5.5% in its September meeting, following a +25 bps hike in July, and in line with market expectations, but signaled there could be another hike this year. Projections released in the dot-plot showed the likelihood of one more increase this year, then two cuts in 2024. Policymakers now see the FFR at 5.6% this year, the same as in the June projection, while it is seen higher at 5.1% in 2024, compared to 4.6% seen in June. Meanwhile, GDP growth is seen higher in 2023 (2.1% vs. 1% seen in June) and 2024 (1.5% vs. 1.1%). PCE inflation was also revised slightly higher to 3.3% this year (vs 3.2%) but was kept at 2.5% for 2024. The core PCE inflation is expected to lower in 2023 (3.7% vs. 3.9%) but was left unchanged for 2024 (at 2.6%). The unemployment rate is projected to lower at 3.8% (vs 4.1%) in 2023 and 4.1% (vs 4.5%) in 2024.
Fed/Powell noted despite some easing, U.S. core inflation is still quite elevated and sticky and also substantially above the Fed’s +2.00% targets (led by core service inflation).
Highlights of Fed’s statement: 20th September’2023
· US Interest Rate Decision Actual 5.5% (Forecast 5.5%, Previous 5.5%)
· Fed projections imply one more 25-basis-point rate hike this year and 50 bps of rate cuts in 2024, versus 100 bps of 2024 cuts in June projections
· Fed Officials' median view of Fed funds rate at end-2025 3.9% (Prior 3.4%)
· Fed Officials' median view of Fed funds rate at end-2024 5.1% (Prior 4.6%).
· Fed Officials' median view of the Fed funds rate at end-2026 2.9%
· Fed Policymakers see much higher GDP growth of 2.1% in 2023, a lower unemployment rate, and more progress on core inflation than they saw in June
· Fed repeats US banking system is sound and resilient
· Fed forecasts show 2023 unemployment at 3.8% v. 4.1% in June
· Fed: Job gains slowed in recent months but remain strong
· The Fed will continue the same pace of QT- reducing Treasury and MBS holdings; pace of QT remains at $95B/Month
· The Fed repeats language on the extent of additional policy-firming
Market reaction after Fed’s statement:
· Traders slash bets on Fed easing next year
· Fed swaps price in lower rate-cut odds for 2024
· Fed swaps show traders pushing back the first rate cut to September 24
· Fed swaps price in higher peak policy rate of 5.49% in January
Full text of Fed’s statement: 20th September 2023- Federal Reserve issues FOMC statement
“Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong, and the unemployment rate has remained low. Inflation remains elevated. The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy.
In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Adriana D. Kugler; Lorie K. Logan; and Christopher J. Waller.”
Implementation Note issued September 20, 2023
Decisions Regarding Monetary Policy Implementation
The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on September 20, 2023:
The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on reserve balances at 5.4 percent, effective September 21, 2023.
As part of its policy decision, the Federal Open Market Committee voted to direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:
"Effective September 21, 2023, the Federal Open Market Committee directs the Desk to:
Undertake open market operations as necessary to maintain the federal funds rate in a target range of 5-1/4 to 5-1/2 percent.
Conduct standing overnight repurchase agreement operations with a minimum bid rate of 5.5 percent and with an aggregate operation limit of $500 billion.
Conduct standing overnight reverse repurchase agreement operations at an offering rate of 5.3 percent and with a per-counterparty limit of $160 billion per day.
Roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.
Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve's holdings of agency debt and agency MBS received in each calendar month that exceeds a cap of $35 billion per month.
Allow modest deviations from stated amounts for reinvestments, if needed for operational reasons.
Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions."
In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 5.5 percent.”
Full text of Fed Chair Powell’s opening statement: 26th July’2023
Full text of Fed Chair Powell’s opening statement: 20th September’2023
My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people. We understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.
Since early last year, the FOMC has significantly tightened its stance on monetary policy. We have raised our policy interest rate by 5-1/4 percentage points and have continued to reduce our securities holdings at a brisk pace. We have covered a lot of ground, and the full effects of our tightening have yet to be felt.
Today we decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings. Looking ahead, we are in a position to proceed carefully in determining the extent of additional policy firming that may be appropriate. Our decisions will be based on our ongoing assessments of the incoming data and the evolving outlook and risks. I will have more to say about monetary policy after briefly reviewing economic developments.
Recent indicators suggest that economic activity has been expanding at a solid pace, and so far this year, growth in real GDP has come in above expectations. Recent readings on consumer spending have been particularly robust. Activity in the housing sector has picked up somewhat, though it remains well below levels of a year ago, largely reflecting higher mortgage rates. Higher interest rates also appear to be weighing on business fixed investment.
In our Summary of Economic Projections, or SEP, Committee participants revised up their assessments of real GDP growth, with the median for this year now at 2.1 percent. Participants expect growth to cool, with the median projection falling to 1.5 percent next year.
The labor market remains tight, but supply and demand conditions continue to come into better balance. Over the past three months, payroll job gains averaged 150 thousand jobs per month, a strong pace that is nevertheless well below that seen earlier in the year. The unemployment rate ticked up in August but remains low, at 3.8 percent. The labor force participation rate has moved up since late last year, particularly for individuals aged 25 to 54 years.
Nominal wage growth has shown some signs of easing, and job vacancies have declined so far this year. Although the jobs-to-workers gap has narrowed, labor demand still exceeds the supply of available workers. FOMC participants expect the rebalancing in the labor market to continue, easing upward inflation pressures. The median unemployment rate projection in the SEP rises from 3.8 percent at the end of this year to 4.1 percent over the next two years.
Inflation remains well above our longer-run goal of 2 percent. Based on the Consumer Price Index and other data, we estimate that total PCE prices rose 3.4 percent over the 12 months ending in August; and that, excluding the volatile food and energy categories, core PCE prices rose 3.9 percent.
Inflation has moderated somewhat since the middle of last year, and longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets. Nevertheless, the process of getting inflation sustainably down to 2 percent has a long way to go. The median projection in the SEP for total PCE inflation is 3.3 percent this year, falls to 2.5 percent next year, and reaches 2 percent in 2026.
The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American people. My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We are highly attentive to the risks that high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective.
As I noted earlier, since early last year, we have raised our policy rate by 5-1/4 percentage points. We see the current stance of monetary policy as restrictive, putting downward pressure on economic activity, hiring, and inflation. In addition, the economy is facing headwinds from tighter credit conditions for households and businesses.
In light of how far we have come in tightening policy, the Committee decided at today’s meeting to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent and to continue the process of significantly reducing our securities holdings. We are committed to achieving and sustaining a stance of monetary policy that is sufficiently restrictive to bring inflation down to our 2 percent goal over time.
In our SEP, FOMC participants wrote down their individual assessments of an appropriate path for the federal funds rate based on what each participant judged to be the most likely scenario going forward. If the economy evolves as projected, the median participant projects that the appropriate level of the federal funds rate will be 5.6 percent at the end of this year, 5.1 percent at the end of 2024, and 3.9 percent at the end of 2025. Compared with our June Summary of Economic Projections, the median projection is unrevised for the end of this year but has moved up by 1/2 percentage point at the end of the next two years.
These projections, of course, are not a Committee decision or plan; if the economy does not evolve as projected, the path for policy will adjust as appropriate to foster our maximum employment and price stability goals. We will continue to make our decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation as well as the balance of risks.
Given how far we have come, we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks. Real interest rates now are well above mainstream estimates of the neutral policy rate, but we are mindful of the inherent uncertainties in precisely gauging the stance of policy. We are prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective.
In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.
We remain committed to bringing inflation back down to our 2 percent goal and to keeping longer-term inflation expectations well anchored. Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the long run.
To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Fed will do everything we can to achieve our maximum employment and price stability goals. Thank you, and I look forward to your questions.”
Highlights of Fed Chair Powell’s comments in the Q&A: 20th September’2023
· Our decisions will be based on assessments of data and risks
· Growth in real GDP has come in above expectations
· We Can proceed carefully
· The Fed has covered a lot of ground, full effects have yet to be felt
· The labor market remains tight
· Higher rates are weighing on business investment
· Consumer spending is particularly robust
· Nominal wage growth has shown some signs of easing
· Unemployment rate at 3.8% remains low
· Labor supply and demand continue to come into better balance
· I expect labor market rebalancing to continue
· Inflation is well above our longer-run goal of 2%
· Inflation has moderated somewhat, expectations appear well-anchored
· The process of getting inflation down to 2% has a long way to go
· The current stance of policy is restrictive
· The Fed estimates core PCE rose 3.9% Y/Y in August
· The FOMC has decided to hold in light of how far we've come
· We will make decisions meeting by meeting
· Fed projections are not a Fed policy plan, policy will adjust as appropriate
· We will keep rates restrictive until confident inflation moves down to 2%
· We are prepared to raise rates further if appropriate
· The FOMC has decided to hold in light of how far we've come
· Reducing inflation is likely to require a period of below-trend growth, some softening of labor conditions
· We will do everything we can to achieve our goals
· We want to see convincing evidence we have reached the appropriate level
· The majority of policymakers believe it is more likely than not that another rate hike will be appropriate
· The fact that we decided to keep the policy rate where it is doesn't mean we have decided-- we have or have not, reached the stance of policy we are seeking
· We will do everything we can to achieve our goals
· Reducing inflation is likely to require a period of below-trend growth, some softening of labor conditions
· I would not want to say summary of economic projections is a sacrosanct plan
· Real interest rates are meaningfully positive
· The SEP is what people think will be appropriate as of now to achieve 2% inflation
· The proposal at the meeting was to maintain the current policy stance; there was unanimous support for that.
· Economic activity has been stronger than expected
· The recent labor market report was a good example of what we want to see
· People want to be careful not to jump to a conclusion one way or the other
· Given how far we have come, we are in a position to proceed carefully and go meeting by meeting
· I wouldn't attribute huge importance to another hike
· We are fairly close to where we need to get
· As a group, it's a pretty tight cluster around the end-of-year rate view
· With the inflation goal closer, we can move carefully
· In terms of the neutral rate, you only know when you get there
· Stronger economic activity is the main reason for needing to do more with rates
· The median of the neutral rate estimate hasn't risen, but people are moving their estimates
· It may be that the neutral rate has risen
· It is a good thing that we've seen meaningful rebalancing in the labor market without much increase in unemployment
· It's also possible that if the path to soft landing has widened, it may be decided by factors outside our control
· I would not call soft landing a baseline expectation
· In the median forecast don't see a big increase in unemployment, but that is not guaranteed
· I still think, and broadly people still think, there will need to be some softening in the labor market
· For now, the question is to try to find the level where we can stay
· The decision we make at the last two meetings this year will depend on the totality of the data
· Part of the decision to cut may be that real rates are rising because inflation is coming down
· GDP is being driven by strong consumer spending
· GDP is not a mandate; the question will be is the heat we see in GDP a threat to the ability to get to 2% inflation
· Strikes, government shutdowns, the resumption of student loan payments, and higher long-term rates, are among the risks
· Higher energy prices, when sustained, can affect inflation
· Government shutdowns don't traditionally have much of a macro effect
· Energy prices being higher is a significant thing
· A strike could affect economic output, hiring, and inflation, but will depend on how broad and how long
· Forecasts are highly uncertain
· A soft landing is a primary objective. That's what we have been trying to achieve
· The last three readings of inflation have been very good, I am well aware that we need more than three good readings
· Growth has come in stronger than expected, requiring higher rates
· As we get closer to the stance of policy that's appropriate, risks become more two-sided
· The risk of overtightening and under-tightening is becoming more equal, need to find our way to the right level of restriction
· Govt shutdown could curtail some of the data we get, would have to deal with that
· We don't need to be in a hurry to get to a conclusion about what we need to do
· It looks like we've had a bit of a turn of inflation in June
· We tend to look through short-term moves in energy prices
· The rise in long-term yields is mostly not about inflation expectations, but more about the growth, and supply of treasuries
· I am seeing measured housing services inflation easing on rents
· If the economy is stronger than expected, the Fed must do more
· We are not looking for a decrease in consumer spending
· Housing supply is structurally constrained
· Any decision about future rate cuts will be about what the economy needs
· I'm seeing real wages are now positive by most measures
· Surveys are showing dissatisfaction with the US economy
· Overall, households are in good shape, with a hot labor market, and rising wages
· The FOMC decided to hold in light of how far we've come
· The FOMC is prepared to raise rates further if appropriate
· I wouldn't call a soft landing a baseline expectation
· A soft landing is the primary objective for the FOMC
The Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a pause in Dec’23.
As per Taylor’s rule, for the US:
Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%
A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); H1CY23 average core inflation around +5.40% (~5.50%)
As there is no significant easing of core inflation, especially core service inflation, the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle. But, if core CPI inflation indeed eased further to below +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).
Also, oil prices may stay elevated in the coming months between $75-90 instead of the earlier $65-75 despite US efforts to bring more supply from Iran, and Venezuela (by lessening sanctions) as OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $80-85 will continue to boost energy/transportation costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $80 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.
The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.
In any way, if average U.S. core CPI inflation indeed falls below +3.50% by June’24 (H1CY24) on a sustainable basis, the Fed may go for a +25 bps cut each in Sep’24 (just ahead of the Nov’24 US Presidential Election) and thereafter every quarter end to keep the real repo rate around +1.0% (from 3M/6M average core inflation).
Looking ahead, from March ’24, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing.
Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election. Also, the Fed is itself in deep loss due to the plunge in bond portfolio (higher bond yields); the same is true for the ECB and other major G10/G20 Central Banks.
Technical trading levels: DJ-30, NQ-100 Future and Gold
Whatever the narrative, technically Dow Future (34485) now has to sustain above 34400 levels for any recovery 34800-35200 levels; otherwise 34200-34000 levels may come soon.
Similarly, NQ-100 Future (14950) now has to sustain over 14900 levels for any recovery to 15425-15725 levels; otherwise 14850/800-600/300 may come.
Gold (1915) now has to sustain above 1910 for any recovery to 1935-1950 levels; otherwise, 1905/1900-1890/1880 may come soon.
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