The US Federal Reserve surprised not many overnight when it decided to maintain interest rates in the range of 5.25 per cent to 5.50 per cent.
However, the “soft landing” rhetoric was omitted from Fed Chair Jerome Powell’s speech half an hour later – a move the market interprets as a sign of an increased likelihood of a US recession.
The term soft landing refers to a scenario in which the US, and consequently the world, can avoid a recession while also bringing inflation in line.
In the latest speech, there were no commitments to a soft landing, a departure from recent tradition.
Powell also highlighted energy prices continue to pose a significant risk to the inflation trajectory narrative, with oil prices recently reaching record highs for the year in 2023. Higher crude prices have driven up US inflation in the latest data.
“Energy prices being higher, that is a significant thing … higher energy prices can affect consumer expectations about inflation,” he said.
The Fed has also indicated the possibility of another rate hike occurring before the beginning of 2024. This was enough to cause a 0.94 per cent decline in the S&P 500.
The Fed also suggested that its tightening policies may have been too mild. The neutral interest rate for the US, which refers to the hypothetical interest rate required to neither contract nor stimulate the economy, might be higher than currently indicated.
The Fed typically uses a 0.5 per cent middle-point range (Note: the Fed uses ranges instead of specific figures, as per the RBA, due to its mandate).
All in all, experts anticipate that interest rates will remain elevated for an extended period, reflecting the newfound view that the Fed will not begin cutting interest rates in 2023, as some had expected. For instance, the RBA does not anticipate inflation to subside until 2025.
This is why the S&P 500 ended the day in the red, despite what would otherwise have been a positive day.
City Index Senior Market Analyst Matt Simpson observed that the Fed continues to monitor incoming data, which represents the most significant potential upside risk to inflation.
“Ultimately, incoming data remains key … higher for longer is here to stay,” Simpson said.
“That is quite apparent with the [treasury] two-year yield at a 17-year high and the 10-year at a 15-year high.”
Typically, when two-year government bond yields surpass 10-year yields, recessions follow shortly afterwards.