What did the Fed minutes said?
On 04th January 2023, the US Federal Reserve published the minutes of the December 2022 Fed meet. It may be recollected that in the December 2022 Fed meet, the FOMC (Federal Open Markets Committee) had hiked the rates by 50 bps from the range of 3.75% to 4.00% to the new range of 4.25% to 4.50%. Overall, since rate hikes started in March 2022, the Fed has hiked rates by a full 425 basis points. However, Fed is not yet done with rate hikes. As per the minutes published on 04th January, the Fed is targeting a terminal rate of interest of 5.1% corresponding to a range of 5.00% to 5.25%. That is another 75 bps rate hikes pending, but that would probably be done in 3 tranches of 25 bps each.
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What the CME Fedwatch tells us about rate trajectory?
The CME Fedwatch table below captures the most concentrated probability of rates in the year 2023 over the next 8 Fed meetings.
| Fed Meet | 450-475 | 475-500 | 500-525 | 525-550 |
| Feb-23 | 68.1% | 31.9% | Nil | Nil |
| Mar-23 | 10.8% | 62.40% | 26.8% | Nil |
| May-23 | 6.1% | 40.1% | 42.2% | 11.6% |
| Jun-23 | 5.7% | 37.8% | 42.1% | 13.6% |
| Jul-23 | 12.1% | 38.7% | 36.4% | 11.1% |
| Sep-23 | 21.4% | 37.95% | 27.5% | 7.4% |
| Nov-23 | 28.3% | 33.6% | 19.2% | 4.5% |
| Dec-23 | 32.1% | 23.1% | 8.5% | 1.4% |
Data source: CME Fedwatch
Here are 3 things you can gather from the CME Fedwatch concentration table. Firstly, another 75 basis points of rate hikes in on the cards in 2023, with an outside possibility of 100 bps in a worst-case scenario. Secondly, the probability of a quick move higher has increased since the Fed statement but the target terminal rate for the Fed rate still stands at 5.1%. Thirdly, the probability of rate cuts in the latter part of the year has come down sharply. This indicates that the rates could stay elevated for longer than originally anticipated. This is also ratified by the FOMC members, who have almost concurred with the view that rate cuts in the year 2023 were almost ruled out and these were more likely in FY24.
Future rate hikes would be data-driven, says the Fed
While confirming that the rate cycle would not turn soon, the Fed has also suggested that going ahead Fed action would be data-driven. It has refused to give any explicit guidance. What this means is that members may not wait for inflation to touch 2%. Instead, they would be happy if inflation showed signs of a sustained glide path towards the 2% mark. That would be good enough. However, as Jerome Power had warned in the past, members concur with the view that slackening the Fed tightness too soon may backfire. In short, Fed's trajectory of rates will depend on inflation, GDP growth, consumption patterns and labour data. The broad takeaway is that rate cuts could be expected only in 2024; not in 2023.
Labour data and taper data cannot be overlooked
These are two very distinct aspects of the Fed minutes. Firstly, the Fed started $95 billion of bond tapering a month from June onwards. Between June and December, the Fed has reduce its balance sheet size from $9.00 trillion to $8.64 trillion. This may look paltry, but that is a lot of impact on liquidity flows in the market and that is already visible in the tightness that we see in global liquidity. What continues to amaze US policymakers is the strong labour data. Labour market was resilient and non-farm payrolls were above expectations for most of 2022. Just to take an example, in the US, the ratio of job openings to available workers is 2:1. Strong labour data is keeping inflation elevated.
Fed minutes and implications for RBI and Indian markets
There are 4 key implications. Firstly, the taper has sucked out $364 billion of liquidity and that is going to impact infusion into India by FPIs, especially passive funds. Secondly, the message for RBI is that Fed is not done with rate hikes, so the RBI has to keep its options open. RBI cannot afford to shift to a pro-growth stance as suggested by Ashima Goyal and Jayanth Varma. Thirdly, the probability of Western economies entering a recession is still quite strong. That has repercussions for Indian merchandise exports, IT revenues and pharma numbers. Fourthly, India may have to adopt a more data-driven approach, rather than a policy approach to inflation. In short, Fed minutes have surely narrowed the options for RBI.
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