On: May 5, 2023 In: Blog, Fixed Income, Knowledge Centre

Federal Open Market Committee (FOMC)

  • Federal Reserve maintains a 25 basis points (bps) rate hike quantum; current Fed Funds Rate now at 5.00% – 5.25%. Amidst a backdrop of stubborn core inflation and the ongoing banking crisis, the US Federal Reserve (Fed) chose to hike the Fed Funds Rate (FFR) by another 25bps to a target range of 5.00% – 5.25%. The smaller 25bps quantum was unanimous among Fed voters and in line with market consensus. Nonetheless, the greater focus lies within the Fed statements which have turned less hawkish, especially with regards to further rate hikes.
  • Fed statement is less hawkish, with major changes in meeting statement suggesting the peak in interest rates is close. Key takeaways from the FOMC statement include a change in language where mentions that “some additional policy tightening may be appropriate” was removed. This is important because the Fed has previously included this sentence as a guide for future rate hikes. However, with the peak in US interest rates fast approaching the Fed has chosen to omit this sentence, which takes into consideration the uncertainty in the US economy and the banking sector. Furthermore, weak loan demand data from US banks next week could cause the narrative for weakening US growth to strengthen, which may mean less rate hikes are required and the peak is at hand.

European Central Bank (ECB)

  • European Central Bank (ECB) slows quantum of rate hikes to 25bps. The ECB opted to go with a 25bps rate hike to bring the deposit rate to 3.25%. For context, this is the seventh straight rate hike in a row (total 375bps) since 2022. The rapid rate hike cycle is mainly attributable to the Eurozone’s sticky inflation situation, although we note that Gross Domestic Product (GDP) growth for the region was barely positive at +0.3% YoY for 1Q23.
  •  The European Central Bank (ECB) reiterates commitment towards fighting inflation, although bank lending and weak economic growth could act as speedbumps. Latest bank survey data from the Eurozone illustrated an environment of weakening credit demand, as European businesses struggled to justify taking up more loans due to the rapid rise in interest rates faced. This is in addition to banks also tightening lending standards, with banks pointing towards a decrease in risk tolerance as a key factor in reducing loan disbursements. We view weakening credit demand as a handbrake on the economy, with households and businesses are likely to cut down on consumption and activity as a result.

Opus View

  • Global inflation outlook has moderated in recent months, but core measures remain elevated. Despite the improvements in headline inflation indicators, core measurements of inflation (Personal Consumption Expenditures (PCE) for the Fed and Consumer Price Index (CPI) for the ECB) still remain well above central bank targets of 2% for both the Fed (Mar’23 core PCE: +4.6% YoY) and the ECB (Apr’23 core CPI: +5.6% YoY).
  •  Interest rates have peaked or are nearing its peak. Despite sticky inflation, we believe that concerns of weakening growth will be the common narrative in 2H2023. The vulnerability of the banking and financial sector to high interest rates are indicators of potential risk to the economy. As such, our view is that interest rates have peaked or are nearing its peak. The Fed is likely to pause or hike at most another 25 bps, while the ECB may hike another 1 – 2 more times of 25 bps each.
  • Bond market to continue to perform despite volatility. With the interest rate hike cycle for many central banks near its end, this will provide support for the bond market. We continue to be positive as there may be further upside as the bond market starts to price in an expectation of rate cuts. However, with inflation still high and the uncertainty of potentially more bank fallouts, we expect the market to continue to be volatile. Hence, we continue to maintain duration of 4 – 6 years which will benefit from a flattening yield curve, without taking too much duration risk.

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