28 Jul 2023
Jose Rasco
Chief Investment Officer, Americas, HSBC Global Private Banking and Wealth
Michael Zervos
Investment Strategy Analyst, HSBC Global Private Banking and Wealth
As expected, at its July meeting, the FOMC voted unanimously to raise policy rates by 0.25% to a range of 5.25-5.5%, which is the highest level for Fed funds in 22 years. It seems clear that the FOMC will closely monitor the data over the next 60 days until their next meeting in September. Our forecast remains unchanged: we believe the Fed is done and will hold rates at the current level till Q2, from where we expect to see three rate cuts in 2024.
The meeting statement was almost unchanged, except for an acknowledgment that economic activity had moved from being ‘modest’ to ‘moderate’. Some investors had feared there could be more of a hawkish tone, but that didn’t materialise. Hence, short-dated bond yields moved slightly lower. Given the lack of big surprises, the immediate impact on other markets was small, but there was a mild risk-on tone supporting global equities and emerging markets, and the USD was slightly lower.
While economic activity has been expanding at a moderate pace (but slowing), job gains have been robust in recent months (labour markets growing more slowly) and the unemployment rate has remained low (expected to rise as higher rates affect growth). Inflation has fallen from 9% to 3% y-o-y but is still above target.
The banking system is sound and resilient (liquidity not a problem). Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation (higher rates = slower growth & inflation).
The FOMC Committee seeks to achieve maximum employment and inflation at the rate of 2%. It decided to raise the target range for the federal funds rate to 5.25-5.5% and will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities.
Looking ahead, the FOMC will continue to monitor the implications of incoming information for the economic outlook and will be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. A wide range of information will be taken into account, including readings on labour market conditions, inflation pressures and inflation expectations, as well as financial and international developments.
Equities should benefit from a pause in policy rates. The current bull market, which began last October, should continue. But investors should prepare for some consolidation and sector rotation as valuations have risen, and the potential of further Fed tightening may cut into future earnings estimates and valuations in the short term. However, the end of the Fed rate hikes should bode well for US equities. Historically, when the Fed pauses its monetary policy tightening cycles, US equity markets tend to do very well, and usually outperform global indices. Moreover, we are at the beginning of a technology led revolution, both lowering the cost of doing business and expanding revenues through the creation of new markets. We remain overweight on US stocks and our cyclical sector positioning.
For fixed income markets, given that we are still near the end of the Fed’s tightening cycle, we extend to a medium duration by acquiring fixed income assets that provide solid yields that may decline in the coming months. While we understand the allure of higher short-term interest rates, an extension of duration seems to make sense given the economic and financial backdrop. For credit markets, we maintain a focus on quality as growth around the world seems to be slowing, and higher interest rates will crimp budgets.
For the US dollar, given that we believe the Fed is closer to the end of its tightening cycle, and its European counterparts at the Bank of England and the European Central Bank may tighten longer, further dollar weakness remains our base case.
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