Market Update

The central stage this week was occupied by the world's most influential central bank, the Federal Reserve (Fed), as policymakers convened to shape US monetary policy.
The ensuing statement proved to be considerably more hawkish than our initial expectations, particularly when examining the shift in the Fed's 'dot plot,' which illustrates each policymaker's projected interest rates for the next three years.
The dot plot caught us off guard entirely: the median forecast now anticipates two interest rate hikes in 2023, a stark contrast to none projected just three months ago. Astonishingly, two policymakers even envision six rate hikes!
This substantial shift in the dot plot puzzles us, particularly when the changes made to their inflation projections are minimal: they now expect 2.1% inflation for 2022, a slight increase from the 2.0% forecasted in March, while 2023 projections remain at 2.1%.
Moreover, these dot plot and inflation forecasts no longer align with the Fed's targets. At the end of last year, the Fed revised its inflation target from a fixed 2% to an average of 2%. This adjustment was intended to permit inflation to surpass 2% temporarily to compensate for the years it remained below that threshold. Unless policymakers consider the current modest inflation overshoot sufficient to offset the period during which inflation averaged just 1.5% since the 2008/9 global financial crisis, these forecasts lack consistency.
Furthermore, since the Fed has explicitly mentioned that it would begin tapering its Quantitative Easing (QE) program (bond purchases) well before any interest rate hikes, this dot plot implies that their previous "we aren't even thinking about thinking about tapering" stance may no longer hold true. Given the timelines involved, they likely must be discussing tapering.
To mitigate the shock factor, as we discussed in our previous Market Update, the dot plot is merely a projection, not a firm commitment. Historically, the dot plot's accuracy in predicting interest rates has been poor, as policymakers have usually leaned towards a more hawkish stance. Additionally, a couple of the more hawkish policymakers who contributed to these projections won't be voting members by 2023.
As a result, despite the evident disapproval from global equity markets, we consider it premature to conclude that the current economic reflation has terminated and that significantly higher interest rates will emerge in the upcoming years. What the Fed communicates often holds more significance than its actions. Thus, we wouldn't be surprised if consumer inflation expectations begin to decline, especially as supply bottlenecks and the surge in demand from reopening start to diminish. This could enable the Fed to maintain an accommodating monetary policy to support complete employment market recovery.
Looking ahead to the upcoming week, the spotlight will be firmly on every speech delivered by a Fed policymaker, including Jay Powell, Loretta Mester, James Bullard, Patrick Harker, and Robert Kaplan. Additionally, there's a Bank of England (BoE) monetary policy meeting, where it will be interesting to hear how policymakers interpret recent economic and inflation data.
Regarding data releases, we anticipate US, UK, Eurozone, and Japanese PMI figures, along with UK and Eurozone consumer confidence readings. Other notable releases include US durable goods orders and US Personal Consumption Expenditure (PCE), which is the Fed's favored inflation metric.