Federal Reserve Board Chair Jerome Powell arrives for the G-20 Finance Ministers and Central Bank Governors meeting on 13 April 2023. AFP.
Federal Reserve Board Chair Jerome Powell arrives for the G-20 Finance Ministers and Central Bank Governors meeting on 13 April 2023. AFP.
Overnight, March’s Federal Reserve meeting minutes and consumer price index (CPI) inflation data both underscored our view that officials will raise the fed funds rate again by 25bps in May to 5.00-5.25%.
Source: Bank of Singapore, Bloomberg
Federal Open Market Committee (FOMC) members noted: “inflation remained much too high and that the labor market remained tight; as a result, they anticipated that some additional policy firming may be appropriate.”
The Fed stayed hawkish on inflation even though last month’s bank failures may hurt credit growth: “recent developments in the banking sector would likely result in tighter credit conditions for households and businesses and weigh on economic activity, hiring, and inflation.”
Source: Bank of Singapore, Bloomberg
Moreover, FOMC members remained hawkish despite March’s bank failures causing the Fed’s staff to forecast a mild recession later this year, similar to our view the economy will contract in the second half of 2023: “given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year.”
Fears inflation will stay above the Fed’s 2% target were reinforced by March’s CPI data last night showing core inflation ticked up to 5.6%. The first chart shows headline inflation dropped from 6.0% to 5.0% on lower food and energy prices. But costlier services continue to drive core inflation to the consternation of Fed officials.
We thus expect the Fed to hike again in May by 25bps before keeping interest rates unchanged at 5.00-5.25% for the rest of the year to curb inflation. As the second chart shows, the fed funds rate is set to remain at levels well above the Fed’s estimate of a neutral rate of 2.50% to the detriment of equities and other risk assets.
We thus stay cautious on the US outlook and continue favouring safe-haven assets including US Treasuries, high-quality corporate bonds and gold. Our base case remains that America’s economy will suffer a recession in the second half of 2023 as the Fed keeps interest rates elevated to continue pushing inflation back to its 2% target over the next couple of years.
