CMB International released a research note stating that the Federal Reserve's latest meeting has re-priced its reaction function under the Powell era. The Fed is set to completely abandon forward guidance, adopting a more flexible policy framework. Decisions will be based on precise real-time data, the transmission effects of the balance sheet, and other factors, with a greater emphasis on the credibility of its 2% inflation target.
The meeting statement removed a significant amount of forward-looking content. The Fed's objective statement shifted from the previous dual mandate focusing on employment and inflation to a singular commitment to "achieving price stability," indicating a notably more hawkish stance from the central bank.
The bank noted that the dot plot forecasts one rate hike by the Fed within the year, representing the primary hawkish signal from this meeting. However, the Fed's actual policy stance may be more dovish. On one hand, the votes for and against a hike were evenly split at 9-9. On the other hand, key voting members this year hold positions that lean more towards a dovish outlook.
Chairman Powell's press conference did not address any forward-looking questions, deliberately presenting a balanced, two-sided view. While emphasizing the inflation target, he downplayed the consensus on rate hike expectations. He announced the formation of five new working groups to reform the Fed's future policy framework.
Reducing forward guidance will grant the Fed greater flexibility and faster policy responses, but it will also significantly increase market volatility. This is because markets will need to repeatedly re-price interest rate paths, potentially leading to more pronounced volatility in front-end rates, the US dollar, and highly-valued equity assets.
Term premiums are expected to rise, and the yield curve may trend towards a bear flattening. The US dollar is likely to strengthen modestly in the short term, while precious metals could face downward pressure.
CMB International maintains its view that a Fed rate hike this year is relatively unlikely. Currently, the Fed is primarily using hawkish communication to guide the market in re-pricing the interest rate path, leveraging tighter financial conditions to achieve some of the effects of a rate hike in advance.
As the US economy slows and inflation subsides in the second half of the year, the bank believes expectations for policy easing have the opportunity to rise substantially.
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