After 25 months and 17 straight meetings of quarter-percentage-point increases in benchmark interest rates, the Federal Open Market Committee decided to hold rates steady Tuesday. The decision keeps the Fed's fed funds rate at 5.25%.
The move gives time to see whether they have raised interest rates enough to cool inflationary pressures, or whether they have put growth at risk by raising rates too much.
The stock market jumped after the decision, but then sold off. Bond prices rose, but then fell back. It is clear that the market does not have a unique interpretation of the move. However, it could not be otherwise: the FOMC kept open all the options.
Further tightening would depend on the economic data, because inflation risks remain. Nonetheless, the ambiguity remains as they said also that price pressures seem likely to moderate over time "reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand." Economic growth "has moderated," due to high energy costs and the gradual cooling of the housing market.
Both views are valid. On one hand the Fed gives the signal that they are still in tightening mode and just took a break. On the other hand they make believe that the economy will slow, making any more rate hikes unnecessary, and even leading to consider cutting rates by the end of the year.
Recent economic data showed the U.S. economy slowing. Job growth has been weaker than expected and the gross domestic product slowed to a 2.5% rate in the second quarter. Slower growth, over time, will reduce inflation pressures and bring core inflation below the Fed's 2% ceiling. There is also concern that the economy may be slowing too fast. The delayed impact of the Fed's past 17 rate increases can last up to 18 months.
I believe that this type of language is not a good thing for markets. The issue is that we are at a turning point in the monetary policy, but they do not want to build confidence in it too early. It would have a significant impact on markets. Better to provide slowly the first signals displaying some possibilities that the interest rates scenario will change.
What is happening is that the smart money is already leaving the cyclical sectors to move towards sectors that might benefit from the policy change.
See in the figure the performance of the various industries during the past 3 months:
Among the best performers you can find Health Care, Fixed lines telecoms, Tobacco, Electricity, Utilities, Pharmaceuticals. Isn’t it a sign of change? I guess so. And the shift will become more and more evident in the next months, when the slow down of the economies will impact on commodities prices.
Small caps, technology and emerging markets present a higher risk in my opinion. It is important that markets develop and digest the policy change without crashes or excessive volatility. What occurred last May to the emerging markets, in fact, might be a first signal of what could happen if the process of reallocation of capitals were too fast.