SYDNEY (BLOOMBERG) - The collective sigh of relief in markets after Federal Reserve chair Jerome Powell pushed back against super-sized hike speculation may be short-lived.
The worry is that without tough action, markets face a toxic combination of persistently high inflation and slower growth.
While the Fed hiked rates by 50 basis points, the most since 2000, and flagged similar moves in the coming months, Mr Powell said 75 basis points were "not something that the committee is actively considering", spurring a rally in stocks and bonds.
Traders had been increasingly betting that the Federal Open Market Committee (FOMC) would opt for an even bigger rate increase to quell the hottest inflation in decades, a move that would also have raised the risks of pushing the economy towards recession.
The S&P 500 Index had its best day since May 2020. Treasuries rallied, with yields on two-year notes retreating 14 basis points. The dollar declined.
Here are some initial reactions from investors and strategists:
Limits of policy
Ms Nancy Davis, founder of Quadratic Capital Management:
"The focus now shifts to the further 200 basis points of rate hikes expected during the rest of the year. These hikes are already priced in. We are puzzled why the market thinks that Fed hikes are going to stop inflation. We believe that there is little monetary policy can do to calm inflation in the near term. We see inflation as driven by massive government spending, supply chain disruptions and, more recently, by Russia's invasion of Ukraine."
Mr David Page, AXA Investment Managers' head of macroeconomic research:
Market reaction "was interesting and highlighted the difficulties of gauging the required scale of future policy tightening".
"Even as the Fed chief was seen as fulfilling market expectations for rate hikes this year and galvanising the broader economy for the effect of rate hikes, financial markets appeared to react to the fact that the Fed was not considering 0.75 per cent hikes - something that was little more than a risk case - and lowered their expectations," he said.
He added: "This marked easing in financial conditions was unlikely to be what the Fed hoped or expected from its press conference. Whether that reflected a myopic focus on 75-basis points rate hikes or a more considered fear of economic slowdown, the easier financial conditions raise the chance of more Fed rate hikes to come."
Don't rule out mega hike
Mr James Knightley, chief international economist, and Mr Padhraic Garvey, regional head of research, Americas, at ING Financial Markets:
"While the Fed likely won't admit it, we are convinced it will be taking a close look at the impact on long-run inflation expectations post the FOMC."
"The 10-year inflation expectation is just about tolerably below a 3 per cent handle. The risk, however, is for inflation expectations to break above 3 per cent. Should that occur, the case for a 75-basis point hike in June would build. The immediate reaction has been muted, on both real rates and inflation expectations, but we need to continue to monitor this important space."
Expect big swings
Mr Steven Englander, head of G-10 FX research at Standard Chartered Bank:
"Today's tone shift is in line with our expectation that both inflation and activity will slow as 2022 progresses, and ultimately be reflected in a significantly lower Fed funds path and USD level. However, until the slower growth trend is well established, the ups and downs of data could produce big swings in expectations and in the tone of Fed commentary."