The US Fed - On road to gradual normalisation

The FOMC left its policy unchanged after its 21-22 September meeting. The inflation outlook will remain important to equity investors, especially as they look ahead to 2022 with the hope that inflation will subside, as supply rises to meet demand. As the business cycle matures, central banks will start to normalise policy, but broad-based rate hikes are still some time off as we are currently in the mid-cycle stage. We do not expect US policy rates to be lifted next year, but the Fed opened the door to tapering, which we now expect to start as soon as November. That said, the impact on markets is benign: through skilled communication, the Fed has been limiting the risk of a taper tantrum.

• The FOMC probably surprised no one by keeping policy rates unchanged. The Committee stated that it "expects it will be appropriate to maintain this target range until labour market conditions have reached levels consistent with the Committee's assessment of maximum employment"
• In considering tapering, the FOMC stated that if progress towards full employment and price stability continues "a moderation in the pace of asset purchases may soon be warranted"
• The Fed lowered its forecast for real economic growth this year to 5.9 per cent from 7.0 per cent. Next year, inflation is expected to be cut in half to 2.2 per cent while real growth is forecast to slow by a third to 3.8 per cent from their 5.9 per cent growth projection for this year. Still, growth will remain above average, and with falling inflation, companies should be able to maintain healthy margins and solid growth in corporate profits
• The upward move in the 'dots' chart, which shows governors' expectation of the future rate path, was seen as somewhat hawkish. But the expectations are no policy guarantee, and the Fed continued to underscore that tapering does not automatically lead to quick rate hikes. We maintain our view that the first rate hike will take place in June 2023
• The market reaction to the meeting was therefore muted. For investors, the Fed's skilled communication, above-trend growth, slowing inflation, and low interest rates are positives for risk appetite. This should extend the business cycle which should continue to support equity valuations in the US. For fixed income investors, rates may remain low but volatile, so the search for yield will continue in high yield and EM bonds, but of course investors should focus on quality and be selective. As for currencies, the policy differential between the Fed and the ECB should help contribute to some mild USD strength