The Federal Reserve (Fed) left interest rates unchanged as expected, but downgraded its economic outlook, citing slower growth and higher inflation due to Trump's tariffs. Wall Street staged a relief rally after Fed Chairman Jerome Powell downplayed inflation concerns.
The Federal Open Market Committee (FOMC) voted on Wednesday to leave the benchmark interest rate unchanged at 4.25 to 4.5 %, as widely expected. However, the committee revised its economic outlook, projecting slower growth due to the impact of tariffs while predicting higher inflation. Fed officials expect inflation (PCE) to be at 2.8 % by the end of this year, up from the December projection of 2.5 %. US economic growth was revised down from 2.1 % to 1.7 %.
Despite the deterioration in the economic outlook, the Fed's dot plot, a chart showing interest rate makers' expectations for the next three years, projects two quarter-percentage point rate cuts this year, remaining the same as in December. The Federal Reserve also announced plans to slow the pace of its balance sheet unwinding starting in April. "Uncertainty around the economic outlook has increased," said the policy makers.
"The Committee is paying attention to the risks on both sides of its dual mandate," they noted, referring to the labour market and inflation. In previous meetings, policymakers removed the formulation that the dual mandate was roughly in balance.
"On the face of it, what came out of the FOMC meeting should be a bearish catalyst," He told Kyle Rodda, chief market analyst at Capital.com Australia. "The dynamics are flashing yellow signals of potential stagflation, or at least a kind of stagflation-lite."
Slower economic growth and higher inflation expectations, which perfectly define a stagflationary business cycle, are seen as bearish for equity markets.
US stock markets jumped
Wall Street rebounded sharply from the Fed's dovish change thanks to a broad rally, with all three major indices ending higher. U.S. equity markets have underperformed their global counterparts this year, particularly European and Chinese stock markets. Economic uncertainty and recession fears have sparked sharp sell-offs, with the S&P 500 index posting a three-week losing streak in correction territory last week.
The market recovery was likely a relief rally as the Fed did not signal a serious economic downturn despite concerns about President Trump's chaotic tariffs. Fed Chairman Powell said he expects inflation caused by the tariffs to be "transitory" and downplayed the risk of a recession.
The rally was also related to the weakening of the US dollar, which was caused by a decline in US Treasury yields as a result of the Fed's cut in growth.
"The Fed's efforts to continue to cut rates cautiously despite rising inflation will result in lower real rates, which tends to weaken the currency and increase the relative attractiveness of equities," Rodda added.
The yield on the two-year interest rate-sensitive government bond fell by seven basis points to 3.97 % and the yield on the ten-year bond by four basis points to 4.24 %. The dollar index fell from an intraday high and ended above 103, a key support level. In contrast, the yield on the German ten-year bond fell only one basis point to 2.8 % and remained at a one-and-a-half-year high. However, the euro weakened following a downward revision of euro area inflation.
However, the recovery in equities may be short-lived despite the Fed's assurances. "'Fed put' remains significantly weaker than in the past few years," wrote in his note Michael Brown, principal analyst at Pepperstone London.A 'Fed put' is the belief that the central bank will limit the stock market decline beyond a certain point through accommodative monetary policy. "This, coupled with the chaotic nature of policymaking in the Oval Office, should keep volatility elevated across equities while leaving equity rallies as a short-term selling opportunity," Brown added.
euronews/ gnews.cz - RoZ
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