THE US CENTRAL BANK GOES BIG

06.05.2022 The US central bank, The Federal Reserve, raised its interest rate (Fed Funds) by half a percentage point to 1 percent on Wednesday. Below we look at the outlook for US interest rates and US asset markets.

The US Federal Reserve raised interest rates this week with the aim of bring inflation, currently 8.5 percent, back under control.  It is expected that there will be two further half percentage increases in the Fed Funds rate announced at its meetings in June and July.

Whilst in the short run inflation is heavily influenced by energy and food prices, in the longer run it is wage (and productivity) trends that dominate. At present the American labour market is tight. Wages are currently growing at around 5 percent on an annual basis. With two job vacancies for every unemployed person the jobs market is unsustainably tight. As a result, growth needs to slow in order to moderate the demand for labour.

The surveys at the start of this month suggest that both the manufacturing sector and the service sector are beginning to slow. As more interest rates rises are announced, growth is likely to decelerate further. At this point markets have priced in a peak for US interest rates of around 3 percent.

The combination of the expected US interest rates rises, the war in Ukraine and lock downs in China should be more than enough to slow the US economy. As a result, US bonds, with a 10 year interest rate of 3 percent, look good value. In contrast US share prices, relative to profits, are still expensive on a historical basis. So, we think that the US stock markets have a bit further to fall.

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This post was written by Robin