On Wednesday, as South Africa celebrated Workers’ Day, the United States (US) Federal Reserve (Fed), once again, took centre stage following the announcement of the Federal Open Market Committee (FOMC) minutes. Investors are growing increasingly concerned about the upward trajectory of US inflation.
Key themes:
- Fed continues with its cautious approach
- Gold retreats below the $2,300/ounce mark
- Fed allays fears of interest rate hikes
- Gold and oil face worst week since February
- Rand gains notably
FEDERAL RESERVE HOLDS STEADY ON INTEREST RATES AMID INFLATION CONCERNS
In response to the recent resurgence of US inflation, the Fed chose to maintain its key interest rate during its most recent two-day FOMC meeting. The decision, announced in a statement following the meeting, reflects the Fed’s cautious stance towards adjusting rates in light of ongoing US inflationary pressures.
The FOMC statement highlighted the Fed’s concern over the lack of progress in moving inflation towards its 2% target in recent months. Currently US inflation ranges between 3% and 4%. The US central bank reiterated its stance that any reduction in interest rates would require the Fed to have greater confidence that inflation is sustainably moving towards its 2% goal.
Fed Chair, Jerome Powell, expressed uncertainty about the timeline for achieving 2% inflation, acknowledging that it might take longer than expected. While Powell anticipates inflation to ease later this year, he admitted to having lower confidence in the timing of that outcome. He noted that the Fed would only consider reducing its benchmark rate if inflation accelerates towards its 2% target or if there’s a significant weakening in the labour market.
Despite concerns about persistent inflation, the statement also highlighted the solid pace of economic expansion and strong job gains. Powell indicated that even if inflation takes longer to subside, it’s unlikely that the Fed will resume hiking rates unless there’s a notable acceleration in consumer prices. This statement positively impacted stock markets.
The decision to maintain interest rates comes after a higher-than-expected inflation reading for the third consecutive month in March. The Fed’s key rate remains unchanged at a 23-year high of 5.25% to 5.5%, with the Central Bank having hiked the federal funds rate 11 times since March 2022 but leaving it unchanged since last July.
Other key takeaways from Powell’s statement include:
- The Fed’s decision to reduce the pace of quantitative tightening as of 1 June 2024, which will lower the cap on the value of Treasury securities rolling off the balance sheet.
- Powell eradicated fears around the possibility of the Fed hiking rates further, however, uncertainty around the timelines of any potential rate cuts persist.
- Powell also moved to dismiss concerns that the economy is entering a period of stagflation. He highlighted the differences between current economic conditions and the stagflation experienced in the 1980s.
POWELL’S REASONS WHY THE US IS NOT IN STAGFLATION TERRITORY
Peaks in Inflation and Interest Rates
During the 1970s and early 1980s inflation soared globally, reaching staggering highs of up to 16% in 1974. This era was marked by rapidly rising prices for commodities, coupled with sluggish economic growth. While some parallels exist with the current economic trajectory of major economies, such as increasing commodity prices and inflation, today’s projected inflation and interest rate peaks are expected to be lower than those experienced in the 1980s. Forecasts suggest that Consumer Price Index increases for major economies may range from 5.5% to 6.5% this year, significantly below the peaks of the 1980s.
Structural Changes
Stagflation in the 1980s unfolded within a different structural landscape, characterised by unique challenges like oil shocks and other factors, which contributed to high inflation and economic stagnation. Over the past four decades, substantial structural shifts have occurred globally, lowering the potential and severity of stagflation. While inflationary pressures persist today, they differ from those of the 1980s due to these structural changes. These conclusions are drawn considering shifts in economic frameworks rather than relying solely on predictive models.
Growth Outlook
Economic growth during the stagflation period of the 1980s was severely hampered, as high inflation and economic stagnation converged. Despite recent economic slowdowns globally, the consensus outlook for gross domestic product-growth in the United States is projected to be 2.6% in 2024, before slowing to 1.8% in 2025 as the economy adapts to high borrowing costs and moderating domestic demand. This outlook, while lower than pre-COVID growth, was more favorable than the economic contraction seen during the 1980s.
While parallels exist between the current economic climate and the stagflation era of the 1980s, notable differences can be observed in the levels of inflation, interest rates, and the severity of economic stagnation. Additionally, the above-mentioned structural changes over the past four decades have influenced the contemporary economic landscape. As such, Powell stresses that markets do not need to be concerned about a recurrence of the stagflation of 40 years ago.
MARKET OVERVIEW
This week’s financial markets were influenced by a range of factors from the Federal Reserve’s policy stance to developments in global commodity prices and movements across the global currency markets.
Bonds
The US 10-year Treasury note saw a decline in its yield, dipping towards 4.6% after hitting a high of 4.7% earlier in the month as markets zeroed in on interest rate remarks by the Fed. Additionally, the Fed announced a slower pace of quantitative tightening, reflecting its cautious approach amidst stubbornly high inflation.
Similarly, the UK 10-year government bond yield also moved lower, approaching the 4.3% mark following recent highs. Investors assessed the global monetary policy outlook following the Fed’s decision to maintain borrowing costs at record high levels. However, Fed Chair Powell’s comments that US rate reductions might take longer than expected, tempered expectations of imminent rate cuts by the Bank of England.
In South Africa, the 10-year government bond yield eased, mirroring movements in its US counterpart. Domestically, the South African Reserve Bank is also expected to maintain interest rates at elevated levels amidst sticky domestic inflation and global market uncertainties.
Equities
US stock indexes saw gains on Thursday, buoyed by the Fed’s assurance that further rate hikes are not on the cards. Market sentiment is reflecting a greater probability of the first rate cut occurring later in the year, with attention turning to today’s key Non-Farm Payrolls report for further insights into the policy trajectory, with options markets betting on high levels of volatility following the release.
In international markets, Frankfurt’s DAX Index edged higher as investors processed the latest FOMC policy decision. Corporate updates, such as pharmaceutical company, Bayer’s favorable legal outcome, contributed to positive market sentiment. Similarly, the FTSE 100 rebounded, driven by upbeat corporate news, including international bank, Standard Chartered’s strong first-quarter performance and energy giant, Shell’s share buyback announcement.
In Japan, the Nikkei 225 and Topix Index experienced slight declines amid fragile market sentiment. The US Fed’s policy decisions and concerns over possible government interventions contributed to the cautious mood among investors.
The Johannesburg Stock Exchange’s JSE All Share Index traded higher, with traders digesting the Fed’s policy outcome alongside economic data and corporate reports. Despite global uncertainties, optimism prevailed, with gains seen in key sectors like telecommunications and retail.
Commodities
Brent Crude futures stabilised near $84/barrel amid speculation of US government interventions to replenish its strategic petroleum reserves, seeing its biggest weekly decline since February Oil prices also took its cues from hopes of a ceasefire in the Middle East and rising US crude inventories. Gold prices briefly dropped below $2,300/ounce as investors assessed the Fed’s policy decision.
Currencies
The US Dollar Index steadied following the Fed’s decision to maintain interest rates and Powell’s dismissal of further rate hikes. However, yen-volatility persisted amid potential Japanese government interventions to stabilise the currency. The euro maintained a downward trend against the dollar, fueled by expectations of a more dovish stance from the European Central Bank compared to the Fed. Similarly, the British pound weakened as investors digested the Fed’s monetary policy decision and its implications for the Bank of England’s policy trajectory.
Closer to home, the rand made strides against all major currencies this week, starting the final trading session for the week on the front foot. At the time of writing, the rand was just over 2.5% stronger against the dollar for the week.
Key Indicators:
USD/ZAR: 18.54
EUR/ZAR: 19.90
GBP/ZAR: 23.27
GOLD: $2,304.22
BRENT CRUDE: $83.83
Sources: Bloomberg, Reuters News, Refinitiv and Trading Economics.
Written by: Citadel Global Director, Bianca Botes.