According to the CME FedWatch tool, 98% of the respondents see the federal funds target range unchanged at 5.25-5.50%.
So, a status quo on rates has been largely factored in by markets. Therefore, all that investors across the globe are looking for is the Fed’s stance on quantitative tightening.
After its last policy meeting in December, the Fed had guided for 75 basis points of rate cuts in 2024, which blew away investors and led to a sharp rally in equities globally. The guidance saw US bond yields tumble from decade highs.
It led to expectations that the policy easing could begin as early as in the first quarter of 2024.
However, the recent set of economic data showed strength in the US economy, suggesting that the Fed may be in no rush to slash borrowing costs. Nonfarm payrolls in the country increased by 216,000 in December, while the economy grew more than expected 3.3% in the December quarter. An increase in the real GDP reflects higher consumer spending, exports, state and local government spending, federal government spending, private inventory investment, and residential fixed investment.
These data points pushed expectations of rate cuts towards mid-2024 and saw bond yields inching up.
“Our outlook is that while the FOMC may start the discussions around tapering QT (quantitative tightening) as soon as at this meeting, tapering itself is still way off, and the actual end of QT
will come early next year,” says Morgan Stanley’s Chief Global Economist, Seth B Carpenter.
Carpenter believes that before an interest rate cut, the reverse repo may be drawn down to zero, and doing that will be the starting point for the taper.
The prevailing macroeconomic conditions do suggest strength in the US economy, but the battle against inflation is far from over. Therefore, the central bank will continue to watch incoming data and keep rates steady until inflation reaches its desired level of 2%.
Ahead of the outcome, the International Monetary Fund on Tuesday said it expects a soft landing for the US economy, with growth slowing to a 2.1% annual rate in 2024 from 2.5% last year. Growth is seen slowing further to 1.7% in 2025.
The IMF’s expectation of a soft landing comes from the fact that the recent decline in inflation was on the back of supply-chain factors, and the Fed did not have to do the whole job of bringing inflation down by rapidly raising interest rates.
How Fed Chairman Jerome Powell and his rate setting committee are reading the current state of the economy will be closely tracked by investors to get a sense of when tapering could actually begin.
“It would be important to see whether the Fed maintains its dovish stance or surprises the market with a hawkish tone,” said Vaibhav Shah, fund manager, Torus ORO PMS.
How Markets Moved Since Last Meeting?
Since Fed’ last meeting in December, the Nifty 50 is up 1.6% while the Dow Jones Industrial Average has gained about 3%.
Yields on the US 10-year treasury note, which were trading at 4.20% before the December meeting, dropped to 3.79% after Fed guided for rate cuts in 2024, but have since then inched up again and are trading at around 4%.
The dollar index has gained 1.5% since the Fed’s December meeting.
The recent inch up in bond yields and dollar has triggered foreign outflows from domestic equities. Their movement post the Fed policy action and commentary will be crucial in deciding FII flow trajectory, going forward.
The Fed meet is being followed by the Interim Budget of the Indian government on Thursday. This too, can have some impact on the overall market.
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