Comments by Franck Dixmier, Global CIO Fixed Income, AllianzGI.
The Fed is likely to hold rates at its June meeting, while leaving the door open to further tightening in the coming months ahead.
- We expect the US Federal Reserve to announce a pause in rate hikes at the Federal Open Market Committee meeting on Wednesday.
- But we believe the Fed should maintain a hawkish stance to leave all options open, including the possibility of a further rate hike in the coming months.
- Recent market adjustments offer investors opportunities to build longer-term positions on the US yield curve.
After ten consecutive rate hikes since March 2022, totaling 500 basis points, investors have two key questions heading into the Federal Open Market Committee (FOMC) meeting: what is the terminal rate – the interest rate level the Fed believes is consistent with a balanced economy – and when will the central bank pivot to a new cycle of rate cuts. These questions have been reflected in recent volatility in market expectations.
We expect the Fed to announce a pause in rate hikes at the FOMC meeting on 13 and 14 June. Despite core inflation remaining too high in relation to the central bank’s price stability objective, we expect the Fed to give itself time to assess the impact of significantly tightening monetary conditions, particularly against the backdrop of a latent regional banking crisis.
Indeed, the recessionary effects of the biggest rate hike in 40 years are beginning to show. Resilient for a long time, US growth is now weakening, as shown by the latest Institute for Supply Management indicators1, particularly in services (50.3 in May compared with 52.4 expected and 51.9 in April).
In addition, tensions in the US banking sector persist. After the second, third and fourth largest bank failures in US history in recent weeks, the Fed’s latest report2 indicates that banks are increasingly tapping financing from the Bank Term Funding Program. Liquidity drawn from the scheme has risen for the fifth week in a row to reach a new peak of USD 100.2 billion. Refinancing conditions in the commercial real estate sector are also a source of concern.
Given this backdrop and the 12–18-month lag generally associated with the full impact of rate hikes on the economy, the Fed can justify a pause. But it is likely to maintain a hawkish stance, leaving all options open, including the possibility of a further hike in the coming months. It will be interesting to see how the Fed updates its growth and inflation scenarios, as well as its projected interest rate outlook. Investors may have to reassess their expectations accordingly.
Given the recent market adjustments, we do not expect any significant impact from the FOMC meeting. The correction in two-year yields (from 3.80% in mid-May to 4.62% on 12 June3) and 10-year yields (from 3.33% in mid-May to 3.76% on 12 June4) in recent weeks has pushed the pivot back. This environment offers investors opportunities to build long positions in the US yield market.
