Why the Fed's interest rate pause was a non-event for markets

The increase in the terminal rate forecast suggests there will be two more 25 basis point hikes this year

US Federal Reserve Chairman Jerome Powell speaks at a news conference following the decision to hold rates steady in June. AFP

The US Federal Reserve's meeting came and went last night and, as expected, the Federal Open Market Committee (FOMC) paused its interest rate rise this month.

However, it increased its 2023 terminal rate forecast to 5.6 per cent, from 5.1 per cent previously.

The terminal rate is a target interest rate set by the Fed to achieve an equilibrium, in which price inflation stabilises and full employment is achieved. The Federal Funds rate is the shorter-term interest rate the central bank uses to achieve the terminal rate.

The increase in the terminal rate forecast suggests that the Fed is considering two more 25 basis point increases this year.

The Fed's statement pointed to continued economic activity expansion, a strong labour market and elevated inflation.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

As a result of the higher-than-expected terminal rate, the Fed's “dot plot”, which shows where it expects rates to be by the end of the year, did show a slightly hawkish title compared with its March meeting.

Judging by the market reaction, the rate decision was largely a non-event.

After initially rallying on the news of a more hawkish dot plot and increased projection of the terminal rate, the US Dollar Index – a measure of the value of the greenback against a weighted basket of major currencies – ultimately settled back to its pre-FOMC meeting levels.

The index actually closed the session on Wednesday marginally down 0.29 per cent, but this was after ensuing weakness earlier in the day through the European session.

Major currencies were also largely unchanged following the short-term dollar bullishness.

The EUR/USD tested 1.08 levels, while the GBP/USD touched 1.2626.

The S&P 500 also rose to 4,335 levels but immediately whipsawed back to pre-FOMC meeting levels above 4,380 before ultimately closing the session up 0.13 per cent.

While we may see some profit-taking and ensuing weakness on Thursday and Friday – with the dollar catching bids – ultimately, the risk-on sentiment looks good to continue through to the end of June and early July.

However, we could possibly be in a position to see a market correction later in July.

In its statement, the Fed noted that the US banking system was “sound and resilient”.

However, it is my opinion that the fallout from the recently concluded debt-ceiling talks has yet to be factored into markets – and this could be a hindrance to any risk-on sentiment.

The Treasury is replenishing it’s Treasury General Account through a co-ordinated liquidity operation, which would result in borrowing at a commercial bank level tightening. The effect it will have on larger markets remains to be seen.

US stocks are on an absolute tear this year, with many of the indexes approaching technical “overbought” levels. The S&P 500 this week hit a 14-month high, while shorter-term US Treasury yields are still stubbornly high.

Ultimately, keep an eye on these yields – two-year yields continue to inch towards its record high of more than 5 per cent, last experienced in March – and more upsides will, no doubt, negatively affect US equities and overall risk sentiment in markets.

Gold has broken through a key technical support level at $1,940 – the 100-day exponential moving average – and it has remained bearish as a result of the recent risk-on sentiment.

The precious metal is set to remain range bound with a bearish bias and will only recover and rally if US Treasury yields increase and sentiment turns in markets.

Adopting a more medium-term view by executing long positions in gold from $1,880 to $1,940 levels, with a plan to exit not before September, could prove good value.