Fed raises interest rates to fight inflation
US economy’s 1.4% contraction doesn’t change Fed plans
The Commerce Department reported that the US economy unexpectedly shrank at a 1.4% annualised pace in the first quarter. Even though the negative growth rate missed the Dow Jones forecast of a 1% increase for the quarter, the initial estimate was the lowest since the pandemic-induced recession in 2020.
The drop was caused by a widening trade deficit. Imports to the United States increased while exports decreased, dynamics reflecting pandemic-related supply-chain constraints. Businesses invested less in inventory in the first quarter after a strong increase at the end of last year, which slowed growth.
The US economy’s major driver is consumer expenditure which rose at a 2.7% annual rate in the first quarter, a slight increase from the end of last year. In addition, many businesses have increased their investments in equipment and R&D, resulting in a 9.2% increase in company spending.
Although GDP shrank, the Federal Reserve is not changing its plans to raise interest rates.
Fed raises interest rates to fight inflation
The Fed raised its short-term interest rate by 0.5 percentage points last Wednesday to get a handle on the worst inflation America has seen in 40 years. The increase of 50 basis points in the Fed funds rate was the biggest since May 2000. Whenever the US central bank has raised rates over the last two decades, it has done so in increments of 25 basis points, but last week’s move highlights the severity of the current inflation threat.
According to CME Group data, the latest hike will push the Fed funds rate to a range of 0.75% to 1%, and current market pricing has the rate rising to between 2.75% and 3% by year’s end.
In addition to raising its interest rate, The Fed announced that it would begin reducing asset holdings on its $9-trillion balance sheet from June 1. During the pandemic, The Fed had been buying bonds to keep interest rates low and money flowing through the economy but when inflation surged, it had to rethink monetary policy.
Stocks surged after the announcement, and Treasury yields fell from their previous high. However, stocks pulled back sharply the following day because investors are fretting over bigger Fed rate hikes and their effect on borrowing costs and growth.
How do higher rates affect Thailand?
For international investors, there are substantial gains to be made from moving money between different countries with different interest rates. Normally, capital flows move to countries with higher interest rates. This will cause the currencies of countries with lower rates to depreciate and the currencies of countries with higher rates to appreciate. However, in this case, the outcome of the Fed meeting was as expected, and the Fed did not signal any significant change in its approach to future rate hikes. This has encouraged market players to gradually reduce their holdings of the dollar (Sell on Fact), forcing the dollar to weaken against major currencies.
After the Fed announcement, the Thai baht appreciated from 34.53 per dollar to 34.05 on Thursday. Nonetheless, other factors will affect the Thai currency such as uncertainty about the Ukraine war and the Covid-19 situation. Investors should keep an eye on fund flows to see whether foreign investors start buying more Thai stocks and bonds or not, once the situation in the financial markets begins to gradually return to accepting more risks.
Apart from currency, monetary policy is one of the things we should keep an eye on because the Fed is one of the central banks that investors and central banks around the world are watching the most closely. However, there are expectations that the Bank of Thailand will not raise interest rates following moves by the Fed or other central banks. This is because headline inflation and core inflation, while already higher than the target range of the Bank of Thailand (BoT) have not yet spread widely.