Fed Holds Rates Steady, Hawkish Tone Persists as Inflation Stall

By Ang Kok Wee, Head of Treasury

Past Week’s Performance Dashboard

● Bitcoin continues to shed volatility as it trades in an uncharacteristically narrow range around USD 43,000 in the past week.

● No surprise from the US Federal Reserve, as it kept interest rates unchanged in last week’s FOMC meeting and maintained a hawkish tone on policy. Strong jobs market boosts the Fed’s confidence to delay cutting rates.

● US equities, particularly those with exposure to tech and AI themes are enjoying tailwinds of strong earnings reports from Amazon and Meta.

● Chinese authorities continue to introduce a swath of market-boosting measures to stabilise its stock markets, including more ETF purchases and a ban on short selling for some hedge funds.

Reticent Fed

Pandemic-induced inflation peaked at 9.2% in June 2022, and although the Fed has made significant progress in its efforts to reign it in, inflation has been stuck around the 3% level in the last seven months.  The Fed is reluctant to declare victory yet as it manoeuvres the “last mile” of its inflation normalisation path.

Meanwhile, recent economic data has boosted the Fed’s confidence in a soft landing for the economy. Notably, last Friday’s employment data surpassed expectations, with an addition of 353,000 jobs in January, maintaining the unemployment rate at a low of 3.7%. This marked the second consecutive month of job creation exceeding 300,000, well above the twelve-month average of 250,000 jobs per month.

In addition, the US service sector showed stronger performance than anticipated in January, with the US Institute for Supply Management (ISM) Services PMI Index reaching a four-month high.

These encouraging signs collectively underscore the resilience of the US job market. Fed Chair Powell said in the “60 Minutes” interview on Sunday that he believes this buys the Fed more time to seek confirmation from data trends and is wary of cutting interest rates too soon. He emphasised that a rate cut in March is unlikely given that it is only short six weeks away.

Rate-Cut Timeline

As the election momentum intensifies following the formal nomination of presidential candidates by the Republican and Democratic parties at their National Conventions in July and August, respectively, the Federal Reserve is likely to avoid delaying rate cuts too far into the election season to prevent any perception of bias in its monetary policy decisions.

So that leaves the window of four FOMC policy meetings between May and September with potentially three or four 25-basis points rate cuts. The rate market is pricing this likely scenario accordingly (Fig. 1).

Fig 1 FOMC Meeting Dates with Corresponding Probabilities of Fed Funds Rates Source CME Fedwatch

Tale of Two Markets

In the US, tailwinds from last week’s earnings report have kept the S&P 500 Index at record levels and is now only 50 points from the psychological level of 5000. The Index has gained 5.5% year-to-date and may still have room for further gains this year if previous election years were to be any guide.

The eight election cycles in the past thirty years suggest that election years yielded an average of 4.8% annual returns. Excluding the recession years of 2000 and 2008, annual returns would be closer to 14% (Fig. 2).

Fig 2 SP 500 Annual Returns on Election Years in the Past Thirty Years

The Fed’s growing confidence in achieving a “soft landing” suggests that the markets could see further gains this year. This view also corroborates with the fact that no incumbent president in modern US history would go on to win a second term during a recession year, hinting at the potential for fiscal stimulus actions and favourable regulatory policies if necessary. Moreover, with the 2022 Inflation Reduction Act by President Biden beginning to roll out its investment spending this year, it could further bolster the economy and stock market during this election cycle.

In contrast, Chinese stocks were caught in another volatile week as market participants assessed the latest pledge by policymakers to stabilise the slumping equity market.

The long-running property slump, weak domestic consumption and tensions with the US continue to rattle investors. Adding to the uncertainty, Donald Trump announced on Monday his intention to implement tariffs of 60% or higher on Chinese imports if he secures a second presidential term, triggering a sell-off in Chinese markets.

There is a sense of urgency to respond as pressure mounts after piecemeal measures over the past few months failed to lift investor sentiment. President Xi plans to convene with regulatory bodies to decide on the forthcoming strategy. This situation mirrors the 2008 financial crisis in the US, where the Federal Reserve had to intervene as a lender of last resort. The issues at the heart of both crises share similarities, with shadow banking playing a pivotal role and becoming a focal point of the turmoil that significantly undermined market confidence.

Potential Market Catalyst This Week

Feb 13 (Tuesday) 0930 hrs

US Consumer Price Index (fc. 3.4% YoY) – This inflation metric measures the changes in prices of all goods and services purchased for consumption against the previous year. Last month’s reading was higher than forecasted, and the index has hovered around 3% since July 2023 (Fig. 3).

Fig 3 US CPI vs Fed Long Term Target Inflation Rate

US Core Consumer Price Index (fc. +0.3% MoM) – same as CPI but excludes the volatile elements of food and energy.   


Narrow Range

It appears Bitcoin may have been overshadowed by important data and macro-events that dominated last week’s market calendar. It traded within a narrow USD 2,000 range and ended up nearly at the same level as it was last week.

On the Spot ETF front, Grayscale Bitcoin Trust (GBTC) outflows continue to slow.  Net flows for all ETFs combined indicated an average gain of USD 120 million per day or approximately USD 600 million last week. Since the approval of the ETF, there has been a net positive inflow of USD 1.6 billion.

Tether, the issuer of the USDT stablecoin, disclosed in its most recent attestation a profit of USD 2.9 billion for the last quarter, summing up to a net profit of USD 6.2 billion last year. A substantial portion of this profitability comes from interest earned on its US Treasury bond holdings, which are part of its liquid asset reserves. The company, which has expressed interest in allocating up to 15% of its quarterly profits to Bitcoin purchases, has already acquired USD 2.8 billion worth of Bitcoin, making it the 11th-largest Bitcoin holder.

Meanwhile, Genesis Capital, the bankrupt crypto trading and lending firm, filed a motion last Friday asking a US judge to approve the sale of over USD 1.6 billion worth of Grayscale’s trust products mostly denominated in Bitcoin. This move, if approved, could lead to further, albeit temporary, selling pressure on Bitcoin, similar to the effects of FTX’s GBTC asset liquidation.

However, these developments did not result in significant price movements for Bitcoin last week. Its price action remained rangebound within USD 42,000 to USD 44,000. Volatility continues to be drained from the market, with implied volatility, particularly for the shorter-dated option expirations, racing lower (Fig. 4).

Fig 4 Bitcoin and Ethereum Implied Volatility

The calm alludes to an accumulation phase with the “buy the dip” price action evident.  This could potentially support the Bitcoin price (Fig. 5), setting the stage for a possible breakout, especially with the Bitcoin halving event looming in ten weeks.

Fig 5 Technical Levels for Bitcoin and Ethereum

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