Thomas Costerg, Senior Economist Pictet Wealth Management.

The Federal Reserve did not seek to surprise markets. It hiked rates as expected by 50bps (some market participants had feared +75bp), after +25bps in March. As expected it also announced Quantitative Tightening – i.e. the ‘passive’ shrinkage of its balance sheet (with a monthly cap on bond redemptions of 45bn initially, then going up to a cruise speed of 95bn/month from August; total balance sheet is currently nearly 9trn).

This is the first 50bp hike at a single meeting since May 2000. The step-up is due to the Fed’s rising anxiety about inflation and wages (CPI was 8.5% yoy in March, ECI private wages were +5.0%yoy in Q1).

Chairman Jerome Powell warned of additional 50bps hikes at the next “couple” of meetings (which he qualifies an “expeditious move”).

Reassuring markets somewhat, Powell said that a 75bps rate hike was not really being considered.

He was vague about the rate outlook beyond the next two meetings. He mentioned the need to move to more “normal” levels in interest rates, without being explicit of what “normal” means. He remained vague about whether Fed rates need to go above “neutral”.

Overall, he left the impression the Fed was more open minded about the future path of tightening than priced in by money markets as he repeated the need to be “nimble”.

He said there is a window to return to +25bp/meeting if inflation is “under control” and starts to “come down”.

From a macro standpoint, the game plan according to Powell is to “reduce job vacancies enough to slow down wage growth”, without necessarily affecting job growth and without “having the unemployment rate go up”.

But Powell acknowledged such a soft landing would be a challenge.

Overall this leaves the feeling that while the current focus is really on inflation, the Fed is starting to introduce more shades of grew with a residual focus on growth/employment. We indeed think economic data (and not just wage/inflation) will be increasingly part of the Fed’s equation in coming months. The Fed could slow the pace of hikes to +25bps as soon as July after +50bp again in June (although we see a risk the shift down only happens by September). But overall we still see a window of opportunity for the Fed to pause tightening later this year as business sentiment surveys and the housing market start to slow (and there are already evidence of that). The Fed’s hawkish rhetoric has already led to sharply rising interest rates which are bound to undermine economic momentum after summer, with housing a particular focus. The risk to this “rate-pause-later” view is still that wage growth continues to accelerate, in which case the Fed could keep hiking at 50bp/meeting into year-end. Then the risk of policy mistake would increase substantially, including the recession risks.