Hawkish US Fed policy stance emerges main trigger for global markets; ICICI Bank sees rate cuts from September

  • This week, the main driver will likely be the US PCE, which is expected to slow at the margin from 0.5 per cent MoM to 0.3 per cent MoM in April, in a positive indicator of the gradual disinflation process for the US Federal Reserve.

Nikita Prasad
First Published28 May 2024
(FILES)This file photo shows the US Federal Reserve in Washington, DC. AFP PHOTO/Karen BLEIER/FILES
(FILES)This file photo shows the US Federal Reserve in Washington, DC. AFP PHOTO/Karen BLEIER/FILES

The US Federal Reserve announced its third interest rate decision for 2024 earlier this month after a two-day Federal Open Market Committee (FOMC) meeting, where it unanimously voted to leave the key benchmark interest rates unchanged at 5.25 per cent - 5.50 per cent for the sixth straight meeting, which was broadly in line with Wall Street estimates and market analysts.

The US central bank has maintained its key overnight interest rate at the 23-year high mark since July 2023 and has now indicated holding rates high until inflation cools and moves consistently to the target range. The FOMC minutes showed that most members remained concerned about the lack of progress on inflation. 

Also Read: US inflation resumes downward trend, eases to 0.3% in April; core CPI cools for first time in 6 months

ICICI Bank sees cuts from September

The FOMC minutes showed that the bar for easing remains fairly high as the need to maintain a restrictive regime was emphasized. The emphasis was on ensuring that policy remained as restrictive as possible to facilitate the disinflation process. Contrary to the FOMC chair Jerome Powell's post-policy press conference comments, the minutes showed that ‘various members’ considered the possibility of having to raise rates if progress remained slow.

The FOMC members believed that labour market re-balancing was churning slowly. While economic growth remains strong, the economy was expected to slow, led by household consumption moderating gradually. Overall, the minutes showed that future actions would remain data-dependent with a bias towards keeping policy restrictive for as long as required.   

ICICI Bank, in its recent research report, said that it retains its view of a possible rate cut commencing from September onwards, with a cumulative 25 bps-50 bps expected over 2024. FOMC's main message was the need for a restrictive policy to remain in place, which worked to push US bond yields higher, supporting the USD in the process.

“The Federal Reserve’s commitment to a higher-for-longer interest rate path, which is intended to keep inflation in check, of course means that borrowing costs remain elevated,” notes Nigel Green, CEO, deVere Group.

“With higher interest rates investors are likely to find opportunities in financial stocks and sectors that benefit from a stronger dollar, such as imports, travel and consumer discretionary. Investors should be cautious about companies with significant debt exposure, as their cost of financing will be high, potentially squeezing margins and profitability,'' added Green.

Also Read: US Fed chair Jerome Powell working from home after testing positive for COVID-19

Impact on US bond yields, dollar 

For the market, the minutes came as hawkish even reminding investors that an immediate pivot towards easing might not unfold in line with expectations. This week, the main driver will likely be the US personal consumption expenditures (PCE) release that is expected to slow at the margin from 0.5 per cent month-on-month (MoM) to 0.3 per cent MoM in April.

Low US PCE, after April's cooler US consumer price data, will be a positive indicator for the US Fed and reinforce that the gradual disinflation profile is unfolding. However, risks to these projections remain to the upside, according to the private lender.

US yields, particularly at the shorter-end moved higher in response to the FOMC minutes. ‘’We do not expect the US PCE inflation to invoke a substantial response in the rates markets. In the near-term, we continue to expect the 2-year to trade in the 4.85 per cent-5.05 per cent range and the 10-year to trade in the 4.40 per cent-4.60 per cent range in the near-term,'' said ICICI Bank.

The US dollar recovered responding to the rise in US yields, and a reminder from the FOMC minutes showed that monetary policy would remain restrictive. FOMC officials are likely to continue to provide a relatively hawkish message to the market that will ensure US yields remain at fairly elevated levels. 

The outlook for the global USD is likely to remain constructive. Elevated US yields could ensure pressure on emerging market currencies remains intact. The reduced geo-political tensions will likely ensure that global commodity prices trade with a downside bias. ‘’We expect broad consolidation in the UDS to continue. We retain our near-term range of 104.50-106.50, although we see downside risk of it moving towards the 104 level,'' said the private lender.

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and individual circumstances may vary.

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