The US Federal Reserve, as expected, left interest rates unchanged, but some of the comments of Chair Jerome Powell sparked rallies in the markets as they hinted that the US central bank may be done with interest rate hikes in the present cycle.

It may be the markets clutching to straws as no significant new information was offered on what the central bank may or may not do going ahead, except that Powell indicated that the risk of overdoing rate hikes or underdoing rate hikes is in balance and that the Fed has slowed down to assess the impact of sharp rate hikes that began 18 months ago.

The key positive for the market was that the two rounds of rate hikes indicated by Fed officials in their projections made in September may not be seen through. Powell merely said a new set of projections will be made in December.

All in all, the view from the Fed is that rates may or may not be hiked henceforth, but they will indeed not be cut in the near future as such a move was not on the table.

There are no signs of a pivot to rate cuts.

The policy rate will stay here or higher for a longer period of time.

Hawkish Pause?

The November Fed meeting is probably more a dovish pause than a hawkish one in so far as signals of more rate hikes are concerned.

Here are the key takeaways from the Fed’s statement:

• FOMC left the benchmark rate unchanged for a second straight meeting in a target range of 5.25-5.50%, a 22-year high.
• The rate-setting body left the door open for more hikes by repeating the language: Will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks.
• The Fed said tighter financial and credit conditions will likely weigh on the economy. It added “financial” to this aspect of the statement, which suggests the Fed believes firm treasury yields may render another rate hike unnecessary.
• The Fed said the economy expanded at a strong pace in the third quarter compared with the prior description of a recent “solid pace”.
• Fed says job gains “have moderated since earlier in the year but remain strong. Wage growth continues, albeit at a slower pace.
• Despite the high bond yields, the Fed reiterated that it will continue to reduce its securities holdings. The Fed trims its sizeable balance sheet at a pace of $95 billion a month after starting to run off securities in June last year.

Supply Side

A key challenge for the Fed has been that the growth has been resilient even in the face of the aggressive interest rate campaign of the Fed. In fact, consumer spending and employment have remained solid, stoking fears of a rebound in inflation.

But Powell took heart from the trend that growth was resilient despite interest rate hikes. He reckoned that it was due to supply catching up to demand.

There has been an unwinding of both demand and supply distortions, and the Fed’s interest rate hikes gave space for supply to catch up to demand.

The job market remaining strong is also due to an increase in the size of the labour market. There is an increase in labour force participation and immigration, which, too, is adding to the GDP growth.

Another reason why the Fed may not consider an increase in interest rates beyond 5.25-5.50% is the likely increase in the potential growth rate of the US.

The unwinding of supply disruptions and the growth in the job market have increased the potential growth rate.

“You could be growing at 2% this year and still be growing below the increase in the potential output of the economy.”

To that extent, a strong labour market and above-trend GDP growth are unlikely to be excessively inflationary.

The US economy expanded at a 4.9% rate last quarter, the fastest clip in almost two years, as consumer spending on discretionary items was strong.

A measure of underlying inflation that’s closely watched by Fed officials also accelerated to a four-month high in September, when job gains blew past expectations.

But the Fed is trying to engineer a slowdown to bring inflation sustainably to 2%. And to that extent, it will keep the option of a rate hike on the table. It will take its decision meeting by meeting.