It was a big week for all financial assets and as it draws to a close, volatility is unlikely to end as the Federal Reserve has given a new direction to the inflation debate.
Over the past few months, the Fed repeatedly maintained a dovish stance despite signs of rising price pressure and improving economic outlook. This led to a complacent attitude in financial markets that interest rates may remain low for a long time and easy money may continue to flow into all asset classes.
While the Fed repeatedly maintained that it would give markets plenty of advance notice before it begins to withdraw the monetary support that began in 2020, the stance this week was clear but not subtle.
The Fed kept the interest rate unchanged at 0-0.25 percent and bond purchases unchanged as expected. It raised inflation and growth forecasts also as anticipated by market players.
However, market players were caught by surprise as the Fed projection showed the possibility of two rate hikes in 2023 as against none in the March meeting.
To keep financial markets calm, Fed Chairman Jerome Powell and other officials said the rising inflation may be transitory. However, with inflation rising at its fastest pace since 2008, it was hard to overlook and chairman Jerome Powell acknowledged that inflation may turn out to be hotter and more persistent than the Fed projected.
The Fed has now primed the market that monetary tightening may begin soon. However, it came at a price in the form of selloff across commodities and equities. US DJIA index slumped to a month’s low, while the dollar index rallied to the highest level since mid-April.
Gold was caught in the eye of the storm and hit the lowest level since April. Gold was already struggling to stay above $1,900 a troy ounce amid increasing debate of impact of rising inflation on monetary policy and shift in the Fed stance pushed it further downhill.
Gold has corrected nearly 8 percent from its recent high set on June 1. Copper and other industrial metals were already under pressure from China's efforts to cool rising prices and weakened further on back of dollar gains. Crude oil remains resilient near $70 a barrel as market players are hopeful of demand recovery.
While market players have reacted sharply to the Fed's announcements, the reaction may subside if the Fed were to say that interest rate may remain low in the near term. The future rate hikes are largely dependent on economic growth and inflation. Further clarity may come from economic numbers as well as comments from central bank officials.
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