Market expects the first US rate increase will come in 2023 as Federal Reserve party continues
The concern about a sustained rise in inflation, and therefore a rise in global interest rates, ultimately forcing the SA Reserve Bank to hike its policy repurchase rate should subside after the US Federal Reserve kept its target monetary policy interest rates unchanged between zero and 0.25% on Wednesday.
The Fed also left its asset purchase programme unchanged, committing to purchase at least $120bn on a monthly basis. That aside, the Fed now appears backward-looking in its monetary policy implementation, and this might have implications for the rest of the world’s monetary policy response function.
The April meeting does not summarise economic projections, so it is not as straightforward to gauge if there is a change in when the first rate hike will come.
The March economic projections indicated the first rate hike coming in 2023. The market was not convinced at the time, pricing in a first rate hike by the fourth quarter of 2021. The market has now adjusted that expectation to some time in 2023. The timing of the first signal for tapering asset purchases is expected in the third quarter of 2021, with a formal announcement expected by the fourth quarter of this year.
The Fed has upgraded its growth forecasts but has committed to keeping policy unchanged for some time, commenting that support for the economy is still far from being withdrawn. Fed chair Jerome Powell was explicit, saying a month’s great jobs report is not enough of an indicator that labour markets are fully recovered.
Another crucial piece of information that came out is the confirmation of my suspicion that the Fed is now backward-looking, a point I asked about with regard to the Reserve Bank’s reaction function, if any, at the last meeting of the monetary policy committee (MPC).
Powell added to his comments on jobs data by saying: “We are going to act on actual data, not our forecast.” These are not my words, but those of the chair of the US Federal Reserve. Actual data is history, and if the Fed acts based on historical data it is backward looking. What effect this will have on the Reserve Bank’s reaction function will be clear only as time goes by, but it will have implications one way or the other.
One possibility would be that the Fed will at some point make a U-turn and implement a surprise change in policy that would not be well signalled ahead of time, just like the 2013 taper tantrum. Tracking this change in language and signals will become very important for policymakers in Pretoria to avoid being surprised and having to overreact, to the detriment of SA markets and the economy.
With US headline inflation for March having surged to 2.6% from 1.7% the month before, the Fed statement should help calm bond vigilantes. The Fed will not react to transitory inflation and it does see an overshoot this year as transitory. In effect, the conducive global financial conditions party continues.
This aligns with the Reserve Bank’s stance that interest rates are likely to remain unchanged for the remainder of the year, which was recently communicated by governor Lesetja Kganyago at a Business Day webinar celebrating the centenary of the bank. To me, this seemed like a slight moderation in view compared with that which was communicated at the March MPC meeting and at the Monetary Policy Review early in April.
The Reserve Bank is now more comfortable with lower policy rates for longer compared with the March MPC. Then, inflation risks were balanced. The quarterly projection model projected 25 basis point hikes in each of the second and fourth quarters of this year, which was a shift in rate expectations by a quarter compared with the January MPC.
All said, interest rates will remain on hold for the remainder of 2021, with hikes likely from the second half of 2022. This will be a welcome reprieve for consumers but it also gives the government some time to continue to implement reforms that will lift growth if successful.