Fed’s Hawkish Stance Extends Interest Rate Hike Cycle, Markets Brace for Further Tightening

Every maneuver executed by the Federal Reserve instigates apprehension within the global financial markets. During the recently concluded Jackson Hole central bank annual assembly, Fed Chairman Powell once again emitted a hawkish indication, stating, ‘We are poised to further augment interest rates under suitable circumstances and intend to uphold policy rates at a constrictive level until we possess unwavering assurance that inflation is aligning with our objectives.’ The objective persists in its descent.”

“The 2-year U.S. bond interest rate, which exhibits greater sensitivity to policy adjustments, has ascended to 5.03%, reaching an unprecedented zenith since July 2007. U.S. stocks have also undergone a correction of approximately 5% since August. The prospect of the Federal Reserve reducing interest rates may now appear distant.”

“From the onset of this year, global financial markets have consistently revised their expectations for the Fed’s policy. Following the eruption of the Silicon Valley Bank incident in March, the market turned increasingly pessimistic about the U.S. economy, anticipating the inaugural interest rate reduction to transpire in July. Subsequently, the Federal Reserve promptly stabilized the liquidity crisis in the banking sector. Nevertheless, the market still anticipates that the tightening of financial conditions will precipitate a precipitous economic decline. As of May, it was still projected that the Federal Reserve would implement interest rate cuts by year-end. However, due to the U.S. economy persistently surpassing expectations, the projected timeline for the initial interest rate reduction has been postponed to June-July 2024.”

“Why has the market consistently underestimated the Federal Reserve’s resoluteness in maintaining elevated interest rates? The downward trajectory of U.S. inflation is undeniable, yet considerable uncertainty shrouds the pace of inflation. Moreover, the U.S. economy appears to exhibit greater resilience compared to previous interest rate hike cycles, thereby accounting for the recurrent misjudgments by the market. The U.S. economy has recently evinced signs of reinvigoration. The Atlanta Fed forecasts that U.S. GDP growth (quarter-on-quarter annualized rate) will attain 5.9% in the third quarter.”

“The termination of the Fed’s interest rate hike cycle does not imply an imminent reduction in interest rates. Instead, it signifies the perpetuation of elevated interest rates for an extended duration. The U.S. economy’s improved performance empowers the Fed to concentrate its efforts on curbing inflation. Powell dedicated a substantial portion of his speech to discussing inflation, thereby underscoring the Fed’s lack of trepidation concerning the state of the economy. This stance may bolster the U.S. bond interest rates to experience further ascension while concurrently restricting the monetary policies of other nations.”

“Why does the ongoing interest rate hike cycle exhibit greater potency than its predecessors?”

“Preconceptions can swiftly transform into inertia. One plausible explanation for the market’s lack of optimism regarding the U.S. economy’s ability to navigate a soft transition under heightened interest rates is attributable to the previous round of interest rate hikes. During the Fed’s interest rate hike cycle spanning from 2016 to 2018, the pace of rate increases was gradual. It took the Fed three years to elevate the benchmark interest rate by 200 basis points. Confronted with a benchmark interest rate of approximately 2.5%, the U.S. economy faltered in 2019, succumbing to a considerable slowdown. Consequently, the Federal Reserve commenced interest rate cuts in the latter half of 2019.”

“However, the current state of the U.S. economy diverges significantly. Despite the Federal Reserve’s sustained and substantial interest rate hikes (resulting in cumulative rate increases exceeding 500 basis points within a year and a half), the U.S. economy has merely experienced a moderate deceleration in the latter half of 2022. By early 2023, numerous vital sectors of the economy will initiate a revival. The Federal Reserve Bank of Atlanta even forecasts that U.S. real GDP will achieve an annualized rate of 5.9% in the third quarter. Furthermore, despite more than a year of continuous interest rate hikes by the Federal Reserve, the average monthly number of new non-farm jobs in the United States remains impressively high at 320,000, surpassing the 180,000 figure observed during the previous round of interest rate hikes.”

“What does a 6% economic growth signify? Over the past two decades, the United States has merely attained an average economic growth rate of approximately 2%. If realized, the forthcoming quarter’s economic growth would be the most remarkable since 2003, excluding the pandemic-induced fluctuations. This portends not even the slightest indication of an imminent recession, but rather an acceleration of the economy. It is no wonder that Powell persistently emphasizes the tenacity of inflation in his discourse, steadfastly advocating the perpetuation of elevated interest rates.”

“The real estate market exhibits heightened sensitivity to interest rates. Yet, U.S. housing prices only experienced a slight decline in the latter half of 2022 (with the S&P/Case-Shiller U.S. National Home Price Index declining by 0.5% from August to December). Despite the interest rate hike cycle, the housing market has demonstrated resilience, suggesting that the impact of elevated interest rates on the real estate sector might be less severe than anticipated.”

“In summary, the ongoing interest rate hike cycle by the Federal Reserve has surprised the market with its resoluteness and the U.S. economy’s ability to withstand higher rates. The market’s pessimistic expectations for interest rate reductions have been repeatedly proven wrong as the U.S. economy continues to show signs of strength and resilience. The Federal Reserve’s focus on curbing inflation and maintaining a constrictive policy stance has led to upward pressure on U.S. bond interest rates. While uncertainties remain, such as the pace of inflation and the potential impact on other nations’ monetary policies, the current interest rate hike cycle appears to have greater potency than its predecessors, supported by the U.S. economy’s performance and the lack of immediate signs of a recession.

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