As expected, the US Federal Reserve (Fed) raised key rates once again while reducing the scope of the adjustment. After four increases of 0.75% between June and November 2022 and an increase of 0.5% in December, its first increase in 2023 was only 0.25%, bringing the principal of its key rates to the range of 4.5%-4.75%.
Fed also noted that it will continue tightening and that further interest increases are expected. This is logical since, although inflation has decreased somewhat in recent months, it remains far too high about its objectives.
The Fed will also continue to reduce its balance sheet, becoming a net seller in the bond market. So far, no surprises.
However, at the press conference following the announcement, Fed President Jerome Powell noted that, for the first time, the disinflation process is taking place. As a result, it took a little while for the markets to start anticipating a near end to the cycle of increases after a last tightening of 0.25% in March that would bring key rates to the 4.75-5.0% range.
Such a scenario should allow the economy to escape the recession and achieve the desired soft landing.
It would delight investors, and their reaction did not wait: the American stock exchanges saw an evident rise while interest rates went down, the 10-year-old around 3.4%.
As for the American dollar, it has lost some feathers in the foreign exchange markets. But, again, the reasoning is that if the Fed is close to the long-awaited key interest rate peak and pivot, other central banks – notably the ECB – still have a long way to go and will have to continue to raise the cost of money rent.
Therefore, the interest rate differential between them and the US dollar is likely to narrow, which weighs on the US currency. This pushes the euro towards USD 1.10, the highest level since Spring.
We continue to invest in U.S. assets (equities, sovereign bonds, high-yield bonds) across our diversified portfolios.
Inflation falls again
Now well below the summer peaks, US inflation is giving investors hope. So the latter started to bet on a Fed pivot that would be relatively close.
The year 2022 ended with inflation in a net decline in the United States. It rose again by 6.5% in December 2022 against December 2021. But it is down 0.1% compared to the previous month, and this is for the first time since May 2020, the period marked by the pandemic and the lockdowns in the United States.
This fall in inflation compared to the previous month, the fall in energy prices (-4.5% compared to November, and even -9% for gasoline) is a factor. For the other goods and services that make up the basket on which inflation is calculated in the United States, the result is more mixed, with increases and decreases everywhere, except housing and associated services, whose price keeps going up. Without them, the monthly decline was -0.5%.
It is, therefore, clear that price pressures are becoming less threatening. Investors will be scrutinising the Federal Reserve in the coming weeks. The latter had indicated that the size of the increases in key interest rates would decrease – a rise of 0.25% is likely at its first meeting of the year - but had also indicated that it expected vital interest rates to rise to more than 5.0% on average over 2023. But in the face of suddenly wiser inflation figures, investors want to believe that the Fed will not go that far and that the pivot (peak of key rates, followed by a fall) is close.
This gives hope to investors and puts the wind back in the sails of financial markets. They believe that without a significant tightening of monetary policy, a soft landing of the world’s largest economy would be within reach. Shortly after the announcement, equity markets rose by almost 2% while US 10-year government debt rates declined to less than 3.5%.
We believe the United States maintains favourable prospects for the medium and long term. So we invest in it across all of our portfolios.