Fed Leaves Rates Unchanged But Dot Plot Projections Hold a Surprise

Above: File image of Jerome Powell, image courtesy of the Federal Reserve.

The Pound to Dollar exchange rate (GBPUSD) retreated from earlier highs amidst a market selloff and a rejuvenated bid for the USD after the Federal Reserve said it would leave its base interest rate unchanged at 5-5.25%, as expected, but more hikes were necessary.

Projections for the future path of interest rates as envisaged by the FOMC - known as the dot plot chart - showed policymakers believe they will be required to deliver a further 50 basis points of rate hikes by year-end.

This could be considered the surprise of the policy event as markets were looking for an outright end to the cycle or a potential further 25bp worth of hikes at most.

"After 10 consecutive interest rate hikes since March 2022, the US economy is in need of a respite - however, markets have been warned to expect a further 50bps by the end of the year, sending equities tumbling," says Oliver Rust, head of product at independent inflation data aggregator Truflation.

Above: The dot plot chart shows Fed members believe they must deliver more hikes by year-end than had previously been assumed in March. Image courtesy of Pantheon Macroeconomics.

"The dots for this year show that two members expect no further hikes; four expect one hike, nine expect two hikes, two expect three hike, and one who hasn’t read the memo about lags and cumulative policy effects expects four," explains Ian Shepherdson, Chief Economist at Pantheon Macroeconomics.

"The new dot plot sparked a sell-off on stocks on Wall Street with recent high enthusiasm ebbing away as investors assess plenty of hurdles ahead before the chance of rate cuts finally appears on the horizon in 2024," says Susannah Streeter, Head of Money and Markets at Hargreaves Lansdown.

The Pound to Dollar exchange rate had printed a new 13-month high at 1.2699 in the lead-up to the Fed decision but retreated on the initial decision and guidance in price action Pound Sterling Live warned of in a preview piece.

The Euro to Dollar exchange rate had been as high as 1.0863 ahead of the decision but retreated to 1.0809 in the wake.

Above: GBPUSD declined as an initial reaction to the Fed decision to hold rates.

The Fed said the decision to pause the rate hiking cycle was necessary because time was needed to see the full impact of previous hikes on the economy.

"Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 per cent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation," said the accompanying statement.

But Federal Reserve Chair Jerome Powell said in his own address to the media that the journey to reaching a 2.0% inflation target still had some way to go, suggesting this was not necessarily the end of the road for the rate hiking cycle.

Indeed, "nearly all" policymakers were of the view some further hikes this year "was appropriate," said Powell

This is a clear pushback at market pricing for interest rate cuts to begin as soon as year-end and certainly by 2024; a communication the Fed will feel is necessary to ensure credit conditions did not ease and stoke inflationary pressures.

Inflation has been on a downtrend over recent months but the Fed views the situation as precarious and will be loath to send an 'all clear' for fear of undoing its recent work.

The Federal Reserve's reticence to call the end of the hiking cycle will have aided some demand for the Dollar which has been under pressure for much of June.

"With prices still rising month-on-month, an inflationary shock could still rear its head and reverse the downward trajectory. As such, though we may be nearing victory in the war against inflation, it’s too early to call in the troops just yet and the Fed is perhaps right to be hawkish," says Oliver Rust, head of product at independent inflation data aggregator Truflation.