Tim Hext: Powell gives the green light after smaller rate rise

Fed chair Jerome Powell today gave the green light to the market’s move to risk-on investing. But it may not last, writes Pendal’s TIM HEXT

JANUARY was a great month for risk. Equities and bonds had strong rallies. Credit spreads contracted.

As we entered February all eyes were on Jerome Powell and the US Fed to see if they would push back on the easing of “financial conditions”.

Here we’re talking about overall financial conditions for the real economy – not just where the Fed Funds rate is.

Financial conditions tries to capture the cost and availability of funding, which impacts spending, saving and investing for businesses and households. Indicators include corporate borrowing rates, US equities and even the US dollar.

Below you can see the Goldman Sachs US Financial Conditions Index, which suggests it’s becoming cheaper to access money or credit.

The Fed’s response?

This morning the US central bank announced a rate rise of 25 percentage points after a year of bigger hikes.

As always, we look to changes in phrasing in the official Fed statement. Today we saw the phrase “extent of future increases” replace “pace of future increases”.

This is interpreted as the debate shifting from last year’s theme of “25bp, 50bp or even 75bp” to “25bp or nothing”.

The Fed is keeping a few more hikes in its “dot plot”, but it’s now distinctly less hawkish.

All this was not unexpected.

Markets really did not react immediately after the statement.

Rather it was Powell’s press conference that saw equities and bonds get a boost.

The first question asked about the recent easing of financial conditions.

Many would have expected Powell to call this out as unwelcome in the fight against inflation.

He did not.

The Fed, like many central banks caught flat-footed a year ago, is now happy to react to data rather than predict it.

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Of course, inflation is a lagging indicator meaning central banks, including the RBA, are happy to sit back and observe these long and variable lags.

Two of the three planks of high US inflation are now in a downtrend. Goods and rents price should ease further in the months ahead and disinflation will be the trend.

However, the third area of services prices remains high. Easing of wages and employment will be need to return to 2 per cent.

Overall though Powell has given the green light to January’s moves to risk-on investing.

February should see that trend continue although at a more modest rate given current levels.

By the middle of the year though, weakness in the economy and falling business margins may see pressures go the other way.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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