Moneycontrol Pro Panorama | A confused Fed leaves markets in the lurch

The hopes for a smoother ride in the market, now that inflation is past its peak, have evaporated

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The market always feared that the US Fed was way behind the curve, but when Federal Reserve Chair Jerome Powell said so, the market reacted negatively by dropping 1.7 percent.

In the currency market, the dollar strengthened sharply against the euro and other major currencies. Bond yields extended their February gains, with the benchmark 10-year yield briefly topping 4 percent for the first time since November 2022 while the 1-year Treasury yield rose above 5 percent.

The US central bank seems to be losing its battle to bring down inflation, despite increasing its benchmark lending rate eight times since early last year. Inflation is still nowhere close to their long-term target of 2 percent.

Powell told the Senate Banking Committee that an "unseasonably warm" January across much of the country was likely behind the robust employment, consumer spending, manufacturing and inflation figures. He said, "If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes," he said. He added that the "ultimate level of interest rates" is likely to be higher than previously anticipated as well.

"The process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy," Powell said, adding. "We will stay the course until the job is done."

The market had discounted the interest rate reduction cycle to start in 2024, but Powell’s comments and data points indicate that the dateline will have to be extended.

For the market, the negative reaction is not merely on account of the chances of higher interest rates but more due to the worry that the Fed is losing the plot.

JP Morgan’s chief economist Michael Feroli explained in a note that the comments made by the Fed chair once again jeopardises the Fed's credibility: “Whereas the plan prior to that data round was to hike by 25 bps until there was more evidence of disinflation, Chair Powell indicated today that they are prepared to throw out that playbook if the February data don’t reverse some of the January strength."

Columnist Tyler Durden writes: "...yet another painful U-turn by a Fed which after ripping up the forward guidance book, is clearly even more clueless now what is going on."

The Fed is looking to accelerate its tightening just as the US economy is staring at a debt ceiling crisis.

Global markets are vulnerable to the Fed moves with the emerging markets likely to feel the brunt of any US market reaction. UBS feels that "yields in Chile and India are most vulnerable over the next 1-3 months. Emerging market ex-China equities appear more vulnerable to a scenario of Fed tightening without a commensurate lift in global trade/ commodities. We note India's relatively high sensitivity to rising local bond yields".

UBS added, "We believe Indian equities have further downside risk on valuations as support from domestic flows has room to weaken further with rates going up/staying high.”

Post Budget, Indian markets are struggling after the Adani fiasco and have yet to regain their footing. A sharper than expected rate increase in the US with an extended timeline will affect inflows to the Indian market.

In short, if central bankers seem to be clueless, the markets will be all the more so. The hopes for a smoother ride in the market, now that inflation is past its peak, have evaporated.

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(These are published every trading day before markets open and can be read on the app)Shishir Asthana
Moneycontrol Pro