Snapshot

Bad news forces Fed to up its game


US interest rates were hiked by 75 basis points on Wednesday in the biggest move since 1994. The Federal Reserve (Fed) also signalled that future moves would be greater and that rates would rise further than previously expected. The so-called dot plot now has rates rising to 3.4% by the end of the year and to 3.8% by end 2023. 

It is quite possible that the Fed would have stuck to its earlier plans of a 50 bps rise had it not been for a double whammy of bad news last Friday. Headline CPI inflation rose to 8.6% and inflation expectations also increased to 3.3%. Fears that inflation has become entrenched and the US is set to experience a wage price spiral were heightened by the figures. 

Clearly, the economy will have to slow by more to bring inflation under control and the Fed also downgraded its growth forecasts to less than 2% for this year and next with higher unemployment. The Fed stopped short of forecasting a recession although chair Powell did say that factors beyond its control could make the outcome worse in his post-meeting press conference. He was referring to the Ukraine conflict and the risk of even higher commodity prices. 

We had already expected policy to be tightened aggressively this year in our recent forecast update, although the pace of rate rises is now looking steeper. Nonetheless, we still believe that evidence of weaker activity and inflation will cause the US central bank to slow the pace of tightening and pause early in 2023. 

Consumer spending is grinding to a standstill as higher prices cut real wage growth. Inventory levels have built up as unsold goods remained in the warehouse. The latest estimate from the Atlanta Fed is for growth of zero in Q2, bringing the US economy to the verge of recession after a negative reading in Q1. The labour market will also need to cool but weaker sales will cause firms to slow hiring as profit margins come under pressure. 

As a consequence we would expect to see inflation easing later in the year and for the tone of Fed announcements to soften. Rates are more likely to be falling than rising by the end of 2023 in our opinion. In the meantime though further tightening lies ahead and an anxious wait for evidence that the economy is responding. 

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.