The US Federal Reserve announced an expected 75 basis point interest rate hike on Wednesday evening. Inflation pain will now have to be carefully weighed against the threat of an economic recession. Equity markets reacted positively to the announced policy.
The S&P added 2.68 percent and the Dow Jones gained almost 1.4 percent. European markets extended Wednesday’s gains in early trading. The Euro Stoxx 50 index traded 0.4 percent higher shortly after the opening.
In order to suppress persistent inflation, interest rates must be raised. The Fed has now become aware of this. In June, US inflation rose to a 40-year high of 9.1 percent, while the Fed considers only 2 percent inflation acceptable in the medium term.
With a second interest rate increase of 0.75 percentage points to a rate of 2.25 percent, the US central bank hopes to apply the economic brakes just hard enough to quell the persistent price increases. More rate hikes in the coming months will be “appropriate”, according to Fed President Jerome Powell (pictured).
Markets react positively
Powell added that as monetary policy tightens further, “the pace of increases is likely to slow as the Fed considers how cumulative policy adjustments affect the economy and inflation”.
Equity markets reacted positively to this. The Dow Jones, the Nasdaq and the S&P 500 all ended the trading session in the green. The Eurostoxx 600 also ended the day with a gain of 0.47 percent.
Mohammed El Erian, economic advisor to Pimco parent Allianz Global Investors, said that it was mainly the unscripted comments by the Fed president that the markets liked.
“The Fed president sometimes has a tendency during his unscripted remarks to focus too much on details that may prove problematic later on. A good example of this is his comment that interest rates are ‘at a neutral level’, followed by a reference to ‘significantly more uncertainty’” El Erian wrote on Twitter.
Recession in the US
The uncomfortable reality for investors is the risk of a too rapid rise in benchmark interest rates after a decade of low interest rates, which could seriously damage the economy. The risk of a recession in the US, and with it in many parts of the world, could be particularly acute in the event of a rapid rise in interest rates.
Fears of recession are partly driven by weaker consumer spending. America’s largest retail company, Walmart, on Monday lowered its profit forecast as rising food and fuel prices prompted customers to reduce their discretionary purchases.
It is precisely that consumer spending that could avert a recession in the US. Investors are therefore divided on whether the Fed will be able to deliver a “soft landing”.
According to the CNBC Fed Survey, which asks fund managers, analysts and economists about the likelihood of a recession in the coming months, 63 per cent of respondents said the Fed’s efforts would lead to a recession in the next 12 months. Only 22 per cent think this will not be the case.
Interest rates will fall
Thomas Costerg, senior economist at Pictet Wealth Management, believes that the Fed will take more account of recessionary risks after the summer and that interest rate hikes will slow down.
Costerg: “I don’t think the Fed will be able to continue to raise rates after December because employment will probably take a sharp turn for the worse, and that will probably be a big red flag for them.”
According to the ING Economics Department, US interest rates will not stay high for long. Over the past 50 years, the average time lag between the Fed’s last and first rate hike in a cycle has been just six months. “This suggests that rate cuts could be possible as early as next summer,” the bank writes in an analysis.
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