Another FED Hawkish 75bp Hike Rates

Fed hiked rates by 75bp as highly expected. Powell delivered a hawkish message, emphasizing the need to tighten financial conditions further. We have not seen Fed make significant progress towards its goals over the past month. It is expected that a 50bp hike will come in February in addition to our earlier forecast for one more 75bp hike in December. Markets took FOMC statement not seriously, but the move faded during the press conference and EUR/USD declined below pre-meeting levels while 2y UST yield rose around 6bp. The forecast for EUR/USD is maintained at 0.93 in 12M.

Fed hiked rates by 75bp in its October meeting as widely expected. There was no updated ‘dot plot’ or economic forecasts. While Powell did acknowledge the downside risks to the economy, he also emphasized that it is very premature to be thinking about stopping.
While there is uncertainty around the lag on how monetary policy tightening impacts the real economy, Powell emphasized that Fed is closely monitoring the development in overall financial conditions. We have not seen real financial conditions tightening over the past month, and instead inflation expectations have ticked slightly higher.

Powell was also clear on the asymmetric balance of risks in terms of policy tightening, which was already flagged in the September minutes. If Fes ends up tightening too much and causing a recession, it can very quickly also reverse its policy stance to more accommodative. But tightening too little risks inflation pressures becoming increasingly entrenched. Prolonged period of high inflation, tight monetary policy and constant need to push the terminal rate higher will eventually increase the risk of unnecessarily deep recession and a clear rise in unemployment. In other words, Fed prefers a short recession over years of stagflation.

Fed needs to continue tightening financial conditions further, and it simply does not have the luxury of giving up on the hawkish stance to achieve this.