The Fed’s next interest rate move will have big ramifications

Traders are watching the US Fed’s next interest rate move with an eagle eye.

Jerome Powell, chair of the board of governors of the US Federal Reserve.

Investors on Wall St have been tentatively betting on – maybe, hoping for - two key pivots. It all starts to boil around dawn Thursday morning down under time.

That’s when the first and most critical pivot will – in my judgment – be delivered; or a lot, and I mean a lot, of punters, and not just in and around the Big Apple, will be sorely disappointed.

This is when the Fed announces its first interest rate decision for the year.

A pivot would be a 25-point; what I would describe as a ‘super-pivot’ would be a pause – if so, the first pause since the Fed started raising rates back last March.

Opinion is broadly split between the Fed repeating its pre-Christmas 50-pointer, or cutting back to 25 points.

There is no chance – or indeed any logical argument for – it to go back to the 75-pointers it was delivering through most of last year, in a desperate attempt to catch up with the inflation it hadn’t seen and hadn’t believed.

I suggest there is almost no chance, now, of it even doing the 50-pointer: the question is how big and how quick a pivot towards the end of rate hikes, Fed head Jerome Powell wants to announce or signal.

He will certainly cut back, in my judgment, to at least the 25 points, and there’s a good chance he could pause while not ruling out further hikes if deemed necessary.

As I’ve been explaining, a very big fall in US inflation has been ‘hiding in plain sight’.

Yes, the annual inflation rate has remained in high single digits, although coming down. But we’ve – or rather, they’ve – had six months of very low monthly inflation.

Over the December half in total, US inflation added to just 0.9 per cent – yes, that’s right, to just under 1 per cent, in total; in Australia over the same six months, in sharp contrast, it’s added to 3.7 per cent.

These low US inflation numbers have coincided with increasing evidence that the US economy is finally slowing; even though the jobs and jobless numbers are still very strong.

I suggest it is particularly instructive that the Fed has pretty much ‘gone silent’ over the last couple of weeks.

As contrasted with the continued and widespread tough-talking at and around its mid-December meeting.

I don’t think it’s been a ‘lack of opportunity’ for Powell and all the other members. I think it’s been deliberate; that the Thursday morning rate pivot is ‘on’.

Wall St has been trading into this broad expectation for some time; recovering through October-November all the 16 per cent slump in the market through August-September, when investors were ‘seeing’ rate hikes, and 75-pointer hikes at that, all the way into 2023.

Since then Wall St has traded broadly sideways – hoping for the ‘rate pivot’, but also increasingly betting on a second ‘Goldilocks’ pivot: that those rate hikes won’t have locked the US economy into an immediate and serious recession.

It’s all about PE – price-earnings – ratios and their valuation relationship to interest rates.

It’s all very well to have rates finally plateau, but if the US economy spiralled into recession, corporate profits would be smashed, and share prices would plummet to bring PEs into sync with rates.

US investors are now punting – more analytically, hoping - that won’t happen; that the end of Fed hikes, or at least a dramatic slowing in any future increases, won’t have smashed the economy and profits.

The current quarterly profits are no guide – they are all about the past, the December quarter.

Just like those annual inflation figures, have all the June half high inflation history.

It’s the March quarter, stupid; and we’ll see those numbers at the end of April. But first, a down under dawn.

Originally published as The Fed’s next interest rate move will have big ramifications