Key takeaways from July FOMC decision

The Fed raised rates by 25 basis points in its July meeting taking the fed funds target range to between 5.25 - 5.50%. The vote was unanimous.1
Even though the Fed has left the door open for an additional rate hike before the end of the year, we believe that we’ve now reached peak cycle – the Fed tightening cycle is done.
There continues to be signs of disinflationary forces at play, and we continue to expect core CPI to ease in July and August, before the next FOMC meeting in September.
A hawkish statement; a dovish press conference
Markets have flip flopped because the statement was hawkish though the press conference was dovish.
While the Fed obviously wants to leave the door open to more rate hikes in an attempt to keep a lid on easing financial conditions, Chair Powell was clear that the Fed is nearing the end of tightening.
He reminded that the Fed has raised the fed funds rate by 525 basis points since March 2022, and was emphatic that monetary policy is now restrictive.
Powell also said that if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive monetary policy level anymore.
He said the Fed could stop raising long before inflation got to 2%, that the Fed could start cutting before inflation got to 2% because inflation is unlikely to get to 2% until 2025.
Yield curve could begin steepening
Looking ahead, we believe it’s likely that the Fed is close to ending the tightening cycle and we expect policy rates to be reduced throughout 2024.
It is our observation that the US yield curve continues to flatten (invert) while the Fed is raising rates and to steepen when it stops.
We therefore expect the yield curve to begin steepening over the coming months and for that to continue throughout 2024.
Investment Implications
In the early stages of steepening, we believe that yields could fall along the curve but that the effect of duration will give better returns at the longer end of the curve.
We believe that equity markets have prematurely anticipated the move to Fed easing and wouldn’t be surprised to see a surrender of recent gains over the coming months before indices eventually move higher.
We expect the dollar to weaken over the next 12 months.
We anticipate volatility in the near term (the Fed is still data dependent), but also expect an increasing global risk appetite as markets continue to positively re-price recession risks, and ultimately look forward to and discount an economic recovery that could begin to unfold late this year.
The risk is that the path of inflation moderation going forward is not satisfactory enough for the Fed to end the hiking cycle.
A prolonged tightening cycle would increase the potential for financial accidents as well as recession risks and prolong the time before an economic recovery could start. This environment would favor near-term defensive investment positioning.
With contributions from Paul Jackson and Kristina Hooper
Reference
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Source: Bloomberg, as of July 26, 2023