What happened?
Global markets slid overnight as the Federal Reserve (Fed) announced it is likely to start hiking interest rates in March for the first time in three years, at the culmination of its two-day Federal Open Market Committee meeting ended Wednesday.
There was no change in policy at the meeting but afterward, in a press conference, the tone of Fed chair Jerome Powell was much more hawkish said observers.
“Inflation risks are still to the upside in the views of most FOMC participants, and certainly in my view as well.
"There’s a risk that the high inflation we are seeing will be prolonged. There’s a risk that it will move even higher. So, we don’t think that’s the base case, but, you asked what the risks are, and we have to be in a position with our monetary policy to address all of the plausible outcomes,” Powell said.
He also mentioned that supply chain issues were taking longer to be resolved than the Fed had originally anticipated.
“In light of the remarkable progress we’ve seen in the labour market and inflation that is well-above our 2% long-run goal, the economy no longer needs sustained high levels of monetary policy support.
“That is why we are phasing out our asset purchases...and we expect it will soon be appropriate to raise the target range for the federal funds rate,” Powell said during a press conference.
This matters because…
With the Fed’s increase in short-term interest rates, it makes borrowing for consumers and businesses more expensive but makes saving more attractive.
It hopes this will slow down the economy, with the incentive to save rather than spend, which in turn should help reduce the skyrocketing inflation levels seen as of late.
US inflation is at its highest point in 40 years, while inflation in the UK in December was 7.5% - its highest level seen since 1991.
The inflation target in both the UK and the US is approximately 2%.
In the Fed’s December meeting it decided to speed up the rate it tapered its purchases of US government bonds and mortgage-backed securities, which essentially gives the Fed more time to raise rates by winding down the program faster.
This announcement will put pressure on the European Central Bank to do the same, as well as the UK’s monetary policy committee to consider further hikes.
The UK did trigger the start of rising interest rates in December by increasing rates to 0.25%, but this is likely to be advanced again, experts said.
“[Tuesday] saw the resumption of the equity selloff as investor jitters remained at the prospect of monetary policy tightening alongside burgeoning geopolitical tensions,” Deutsche Bank said.
Technology stocks lose value when interest rates rise because they are ‘growth’ stocks, which means they give high returns in the distant future and higher rates squeezing consumer spending power puts a question mark about growth assumptions.
Powell admitted he did not foresee the persistence of high inflation, which has now led to prices rising in areas not even impacted by supply shortages, as he believed it to be temporary.
Market Reaction
Foostie had a rollercoaster morning on Thursday.
Early calls that Footsie would fall 100 points lower were quickly proved wide of the mark as the banks rose on the prospect of a windfall gain from higher rates on mortgages and other loans.
The FTSE 250 was perhaps a better guide to the underlying picture, shedding 180 points or 0.8%.
It is more reflective of the UK economy generally and does not contain the high street banks.
US markets fell sharply following the conclusion of Powell's news conference on Wednesday as Treasury bond yields climbed.
Early futures pointed to further losses on Thursday.
Stocks plummeted in Asia overnight to a 15-month low with Japan's Nikkei easing 3%.
Strategists at the world’s leading investment banks rushed to alter their Federal Reserve rate calls today following the announcement to tighten policy and clamp down on inflation.
What brokers say
Most market analysts expected the Fed’s nudge towards a quarter-percentage point rise with Diane Swonk, chief economist at Grant Thornton consulting firm, insisting the half-point raise was very unlikely.
“That would signal a real panic,” she said. “The Fed likes orderly things.”
Four quarter-percentage-point hikes are expected this year, Goldman Sachs (NYSE:GS) economist David Mericle said, but we could see a faster pace of rate increases.
“Our baseline forecast calls for four hikes in March, June, September, and December,” Mericle said in a note to clients.
“Asian markets are currently being affected by volatility in global markets, concerns about Fed tightening in the face of higher inflation, and uncertainty about events in Russia and Ukraine,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore.
“I certainly am feeling positive towards the European stock markets compared to Wall Street. Indeed, European markets are more likely to suffer smaller setbacks going forward because unlike the Fed, the ECB is going to keep printing more QE money for longer,” Fawad Razaqzada, Think Markets analyst, said.