Market focus: All eyes on the Fed’s May Meeting

US Federal Reserve to release Federal Funds rate on 03 May

This Wednesday, the US Federal Reserve is scheduled to release the Federal Funds Rate. CME polls indicate an expected rate hike of approximately 25 basis points, with over 85% of respondents predicting the same. Investors will be closely watching the Fed's decision and any accompanying statement for hints about future rate decisions and the overall state of the economy. The Fed's decisions can have a ripple effect throughout the global financial markets, so it's important for investors to stay informed and react accordingly.

Diverging expectations on interest rates beyond May

Both the Federal Reserve and the markets seem to agree that a 25-basis point increase in interest rates may be appropriate in May. However, beyond May, the expectations for future rate hikes diverge. The Federal Reserve's projections suggest that interest rates will remain relatively steady, and markets expect them to stay volatile. Despite the divergence in projections, both the Federal Reserve and the markets seem to agree that interest rates will remain elevated for the rest of the year, although the timing and magnitude of any potential adjustments may vary. These differing expectations are influenced by economic data and indicators, and they could change depending on the evolving economic situation.

At the last meeting Jerome Powell, the Chairman of the US Federal Reserve, indicated that the bank will discuss all economic data that appears before making any decision. As we can conclude from his speech that the Federal Reserve will put confidence in the numbers, it will be essential to consider the most important economic data that has recently appeared.

Inflation and the labor market's impact on interest rates

Inflation is a crucial factor that affects the Fed's decision on interest rates. The reading of the Personal Consumption Expenditure Index (PCE index), which is the preferred indicator of the US Federal Reserve, was released last Friday. The index fell to 4.2% on an annual basis in April, which is the lowest reading since July 2021. It can be said that the decline in the reading of the US Fed Reserve’s preferred inflation index is a significant achievement. However, the reading was still far from a healthy inflation level at 2%. In addition, we did not witness any change in individual spending during the month of March, at a time when personal income increased by 0.3%, equivalent to $67.9 billion.

The labor market is another crucial factor that affects the Fed's decision on interest rates. According to the latest US jobs report, the unemployment rate fell from 3.6% in February to 3.5%, and the economy added 263 thousand jobs in the non-farm sector, which is the lowest since the beginning of this year.

Market reactions to the Fed's decision

Ultimately, the impact of the Fed's decision on American currency and market sectors will depend on a variety of factors, including the strength of the US economy, inflationary pressures, and geopolitical tensions. Investors will be closely watching the Fed's decision and any subsequent commentary for clues about the central bank's future policy direction, and how the markets are likely to be impacted in the coming months.

It is important to note that market reactions to federal decisions can be unpredictable at times, but generally a rate hike causes the US dollar to strengthen, while a rate cut leads to depreciation. The stock market may also react, with some stocks experiencing gains and others losses.

Bets have risen about whether the bank will stop raising the interest rate past 5.25% after the May meeting. If it reaches 5.1% in 2023, the markets may begin to doubt the extent of the US Federal Reserve's credibility and accuracy, or it may increase the possibility that the Federal Reserve will start reducing interest rates to reach the level of 5.1%, especially since the trend indicated a decline in the federal interest rate to 4.3% in 2023-2024.

The US Federal Reserve has raised the interest rate by about 450 points since March 2022. Chairman Powell has indicated in every meeting of the Fed that they will continue to raise the interest rate until it sees a noticeable result. Since the beginning of the Fed’s monetary tightening in 2021, the bank started with 50 basis points, followed by four increases of about 75 basis points. However, this has accelerated in 2023, as the Fed has raised the interest rate twice by about 25 basis points since January.

Potential outcomes of another increase in interest rates

A potential outcome of a 25-basis point increase in interest rates could be a resurgence of positive momentum for the US dollar index. On 01 May 2023, the dollar index surpassed the 102 thresholds in trading, marking the first time in three weeks. It is noteworthy that the dollar index has rebounded four times from a support level of 101.50 since April 2022. Therefore, a failure to break this level and a subsequent settling below it could signal a negative trend for the US dollar index.

If the bank were to fix the interest rate at 5.00% without any increase, the probability of this occurrence, according to CME statistics, is estimated to be 2.6%. However, such an event could theoretically stir panic and uncertainty in the market. This could result in fluctuations in the price of gold, particularly since it has recently settled within a range of 1980-2000. However, some investors may view this as an opportunity to benefit from the situation, particularly amid concerns of another looming financial crisis. Ultimately, the outcome of such a scenario remains uncertain and will depend on a variety of economic factors and market conditions.

No matter the outcome, the US Federal Reserve's decision on interest rates is a crucial event for investors and the broader financial markets. While there are differing opinions and possibilities regarding the direction of interest rates, the release of the Federal Funds Rate on Wednesday will give us a clearer picture of the Fed's stance on monetary policy. Investors should stay informed about the latest economic data and market developments to make informed decisions about their investments.