In line with consensus expectations, the FOMC unanimously voted in favour of hiking interest rates by 25bps on Wednesday evening, taking the lower and upper limit of the Fed Funds Rate to 4.50% and 4.75%, respectively. This brings the cumulative rate hikes over the past year to 450bps. The big takeout from the FOMC statement was – “ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” which implies at least two more rate hikes, 25ps in March and 25bps in May.

While market moves in the minutes following the announcement were contained, fed funds futures were initially pricing in slightly higher odds of another 25bps hike (85% probability in March) and 25bps in May ( around 50% probability). That said, the professional market is still pricing in a terminal rate of below 5.00%, implying that markets aren’t entirely convinced that the Fed will deliver on the guidance provided in the January FOMC statement.

The overarching tone of Powell’s comments was assessed to be relatively hawkish as the Fed Chairman pushed to contain inflation expectations against the backdrop of the easing in financial conditions in recent weeks. Powell reiterated that monetary policy needs to remain restrictive for some time in order for inflation to come back down to the 2% target. Powell noted that the Fed would remain data dependent in the months ahead, adding that it would change the course of monetary if deemed necessary. Powell said it is encouraging that inflation has slowed but cautioned that inflation could rebound in the months ahead. 

In conclusion, the divergence between markets and the Fed remains intact despite the relatively hawkish policy statement and forward guidance from Fed Chair Powell. The Fed statement implies a terminal rate of 5.25% in the current tightening cycle, while the market is pricing in peak rates of just below 5.00%, with the June swap rate holding at around 4.93%. While the 2yr US Treasury ticked higher following the release of the policy statement, the 2yr yield dropped by more than 10bps during Powell’s speech. The USD meanwhile came under considerable selling pressure in the wake of Powell’s speech as the market stuck to its guns that the Fed would ease rates by the end of the year.