Post Market Wrap | Federal Reserve raises interest rate by a quarter of one percent
This Post Market Wrap is presented by KOSEC – Kodari Securities
- Strong wages growth, rising employment and higher energy costs fuelling inflation
- Likelihood of 2 percent interest rate by end of calendar year 2022
- Consensus is for 3 percent interest rate by end of calendar year 2023
- Announcement widely anticipated and well received by market generally
US Interest Rate Rise
The U.S. Federal Reserve board decided to raise the Federal Funds Rate by a quarter of a percent overnight to a target range of a quarter to a half percent. The Federal Reserve referred to strong employment growth and elevated inflation levels as the primary reasons for its decision. Reference was also made to the Russian invasion of Ukraine which is creating upward pressure on energy prices.
The rate rise was widely anticipated by the bond market, which is why long-term bond rates barely moved on the announcement. The bond market has been telling us for months that we have an inflation problem, with long dated bond yields rising steadily in the lead-up to last night’s Federal Reserve announcement.
The Federal Open Market Committee (FOMC) stated that economic indicators including employment and wages growth reveal that the US economy is strong. These circumstances, while supporting a rise in economic activity, when accompanied by a tight labour market, call for decisive action on the interest rate front. In the view of FOMC officials, signs of inflation early last year were attributed to supply chain constraints brought about by lockdowns related to the global COVID-19 pandemic. However, their view now is that inflation is more broadly based, and the most appropriate response is higher interest rates.
Why is the Federal Funds Rate important?
The Federal Funds Rate is the overnight rate at which the Federal Reserve lends to US banks and so is the benchmark rate at which banks lend to and borrow from each other. If this rate rises, US banks pass on this higher interest rate to their customers. This includes consumer and business loans. The ultimate outcome is less borrowing which restrains spending and this reduces inflationary pressures, because the ability to pass on price rises throughout the economy, is diminished. Once the inflationary pressures ease, interest rates stabilise, enabling the economy to steadily grow at a sustainable rate. This rhythmic pattern is known as the economic cycle.
In its market release accompanying the rate rise, the FOMC stated it intends to continue raising rates so that the Federal Fund Rate reverts to at least the level that prevailed prior the onset of the global pandemic. The target date to achieve this is the end of calendar year 2022. This statement implies that the FOMC plan 6 more rate rises of a quarter of a percent, over the coming 9 months. This will take the Federal Funds Rate to 2 percent. The bond market appears relaxed at this prospect, because it is widely recognised that the extraordinary decision to cut interest rates to zero at the height of the pandemic was always a temporary measure to deal with a one in a hundred-year event.
Equity markets around the globe, including Australia, have also responded positively to the FOMC announcement of a sustained period of interest rate rises over the coming 2 years. This was exemplified by a sharp 1.5 percent rise in the Dow Jones Industrial Index and a 2.2 percent rise in the broader S & P 500 Index and a 3.7 percent jump in the technology heavy NASDAQ, as the FOMC decision was released. Australian markets are also higher today, with the ASX200 up 1.05 percent and the broader All Ords Index up 1.16 percent. History shows that equity markets tend to follow the economy, not the interest rate. This has been confirmed by the strong equity markets seen immediately post the FOMC announcement.
Beyond the 2 percent target interest rate by the end of 2022, market consensus is for a 2.75 to 3 percent interest rate by end of calendar year 2023. Beyond 2023, present market consensus is that rates would not need to be raised above 3 percent.
This scenario poses little or no threat to the medium-term economic outlook and should support equity and debt markets as well.
This Post Market Wrap is presented by Kodari Securities, written by Michael Kodari, CEO at KOSEC.
When will airfares begin to fall?
As the global aviation market rebounds, airlines are changing their service offerings
Over 46 million workers in the global aviation sector lost their jobs as global aviation came to a grinding halt at the onset of the pandemic.
However, Geoffrey Thomas from AirlineRatings.com said passengers have returned to airport terminals and boarded flights in droves.
“When travelled returned, many of us wondered what sort of low airfares will we have to be charged to entice people back onto airplanes.”
In February 2023, total traffic (measured in revenue passenger kilometres) rose 55.5 per cent when compared to February 2022.
Globally, traffic is at 84.9 per cent of February 2019 levels.
“It was a stampede, the likes of which we have never seen before,” Mr Thomas said.
The worst of inflation could be behind us
The unprecedented nature of the pandemic continue to shape international fiscal policy
As reserve banks and federal reserves continue to battle the impacts of Covid-19, inflation has become a dominate issue.
In some parts of the world, rising household costs have slowed consumer spending by more than expected.
It means the end of aggressive rate hikes could come to an end in a matter of months.
In Australia, recent data from the Australian Bureau of Statistics confirmed inflation has passed its peak and is beginning to moderate.
The numbers show annual inflation peaked in December 2022 but will still remain higher for longer than anticipated.
Matt Grudnoff is a Senior Economist at The Australia Institute, who said these are uncharted waters.
“I don’t think they should be fully blamed.
“The pandemic was an entirely different kind of recession, one that we have never seen before.
“The world went into recession because the world shut down for very good health reasons.
“But the economy rebounded extremely quickly, simply because there was no underlying problem with the economy,” he said.
“I think there is a great risk”: will AI steal our jobs?
Artificial Intelligence has become an increasingly powerful and pervasive force in our modern world.
Artificial intelligence is not a new concept. However, the growing advancements have the potential to revolutionise industries, improve efficiency, and enhance the quality of life.
Along with its promising advancements, artificial intelligence also brings certain risks and challenges that must be acknowledged and addressed.
It has become the focus of lawmakers, who are working towards greater regulation of the sector.
U.S. and European Union officials recently met in Sweden to weigh up the benefits and challenges of artificial intelligence, and other emerging technologies.
“The AI process is creeping up on us,” said Dr Keith Suter, who is a global futurist.
“You’ve got competition between companies.”
It’s almost like some of us can see this raft that’s heading towards the rapids and a disappearance towards the waterfall, and we’re giving a warning but it’s not being heeded because everybody’s in this race to get down to the river,” Dr Suter said.
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