A dovish hike but Fed may be forced to do more

A dovish hike but Fed may be forced to do more

This is the most aggressive sequence of hikes since the Volcker years. Chair Powell kept the option of another 75 basis-point rise on the table but caveated it by highlighting the importance of short-term data.

What happened?

As widely expected, the Federal Reserve (Fed) raised interest rates by another 75 basis points in July in what is now the most aggressive sequence of hikes since Paul Volcker was in charge at the US central bank in the early 1980s. Much higher-than-expected inflation remains the key driver here together with ongoing strength in the labour market. At the press conference, Chair Powell kept the option of another 75 bps on the table but caveated it by highlighting the importance of short-term data. Powell also said the Fed is now in meeting-to-meeting mode with less focus on specific guidance. 

Our interpretation

We are now entering the phase of the cycle where the Fed has delivered significant tightening in a very short period. The economy is sending conflicting signals with soft data in recessionary territory whilst hard data, especially on the labour market side, is still showing ongoing resilience. With inflation continuing to surprise on the upside, without a visible slowdown in the job market, the risk of another 75 bps rise remains high. The Fed is looking at hard data which is lagging and may be forced into another burst of aggressive tightening. That said, there was more flexibility in Chair Powell’s comments at this meeting than had been the case over the last two meetings.

Our outlook

We have been of the view that the Fed would end up hiking less than market pricing. At one point, the markets priced in a terminal rate of 4 per cent which we thought was too high. We agree with the current set-up which sees the terminal rate for this cycle at around 3.25 per cent. However, the economy is sending conflicting signals and the strength of lagging hard data on which the Fed is focused may change the near-term trajectory for rates. Our base case remains one of recession in the US over the next six months given the tightening in financial conditions and slump in consumer confidence.

Asset allocation implications

We remain cautious on equity and credit with a positive view on duration given the rising risk of a severe slowdown in growth as a result of the front-loaded Fed tightening.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009.

© 2022 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.


Want more insights like this?

Get our free, monthly e-newsletter bringing you valuable insights, opinion and education.