8 mins read . 31 Jul 2023
There was not much of a surprise element in the Fed hiking rates in the July 26, 2023 meeting. As expected, the Fed hiked the rates by 25 bps, taking the rates to the level of 5.25% to 5.50%. That is a full 525 basis points from the level of March 2022 when the rate hikes started off for the first time. However, the July rate hike was never in question. The big question was whether this would be the last rate hike or will there be one more rate hike by the Fed as indicated by Jerome Powell, the Fed chair? While the Fed has been non-committal in the meeting, its statement has been interpreted in a fairly interesting way. Fed had stated that they could opt for a longer pause, and that has been interpreted by the market as a signal that the Fed may be done and dusted with its rate hike program. What really supported the view was the flow from two sets of data this week.
In the US Q2 refers to the period to June, since the US follows the calendar year cycle. After growing at 2% in the first quarter ended March 2023, the first advance estimate of GDP growth in Q2 has come in higher at 2.4%. This is not just higher than the sequential quarter but also higher than the street consensus estimates of 1.8% to 2.0% GDP growth in the second quarter. The spike in the real growth was, however, led by falling inflation, which is a good sign. However, the nominal GDP growth has actually fallen sharply in the June quarter. The Fed would be happy with the fact that the higher real GDP growth in the June quarter has been driven by lower inflation, rather than nominal growth. However, the Fed would not want to get into a situation wherein the nominal growth comes under pressure. That makes a strong case for the Fed to pause now, although the pause could be long.
On July 28, 2023 the US Bureau of Economic Analysis also announced the personal consumption expenditure (PCE) based inflation. The PCE inflation is relevant as it is a barometer of consumption spending and also of inflation. It is the PCE inflation, and not the consumer inflation, that the Fed uses for its rate decisions. For the month of June 2023, the PCE inflation came in sharply lower at 3% at a headline level while the core PCE inflation also fell by 50 bps to 4.1%. It is the core PCE inflation that the Fed has been trying hard to bring down. The Fed target is to first bring down the headline PCE inflation to 2% and then bring the core PCE inflation down to 2%. Now, both these appear to be on track, which is another factor that could spur the Fed to go slow and call a halt on rate hikes for now. That is what the CME Fedwatch is also indicating after these data flows came in.
While the GDP data and the PCE inflation date are fairly emphatic about falling inflation and the chances of a rate pause after July, even the Fed statement broadly appears to hint at that possibility. Of course, the Fed statement was still ambiguous on the likelihood of future rates, but that is more because the Fed always wants to keep one escape window open. Here are some of the key takeaways form the Fed statement.
For India, this is good news as it would put less pressure on the RBI to hike rates to avoid monetary divergence. That may not be necessary now. The taper could tighten passive flows into India, but that is not really showing up. What India would relish is the statement by Powell, “It is possible that Fed would choose to hold steady and as we make careful assessments, meeting by meeting.” That is as close to a less hawkish statement as the Indian central bank can hope for. That is; assuming that macros do not worsen in the US.