S&P/ASX 200 Index (ASX: XJO) shares are charging ahead in early trade, putting the benchmark index up 0.8%.
This comes after a strong performance in US markets yesterday (overnight Aussie time) following on the latest 0.75% interest rate hike by the US Federal Reserve.
The S&P 500 finished the day up 2.6% and ASX 200 shares are giving chase.
Image source: Getty Images
Why did the US Fed hike rates?
As in Australia, where inflation just notched 20-year highs of 6.1%, inflation in the US is running hot.
Even hotter than down under, with US CPI figures leaping 9.1% in June year-on-year, the fastest pace of price increases in 40 years.
This saw the US Fed lift interest rates by 0.75% for the second consecutive month, bringing the official US interest rate to a range of 2.25% to 2.50%.
Federal Reserve chair Jerome Powell indicated another outsized increase was on the table for next month, saying "another unusually large increase could be appropriate at our next meeting".
However, he said the Fed would not be giving specific guidance on the next rate increase. The committee will take into account new data that comes in over the next weeks before making any decisions.
Powell also dismissed fears that the world's largest economy was heading for a recession, citing the strength of the US labour market while admitting that "spending and production have softened".
He added that the Fed is aiming to slow the pace of the economy, however.
"We actually think we need a period of growth below potential in order to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labour market conditions," Powell said.
Why are ASX 200 shares surging on this news?
ASX 200 shares don't operate in an Australian bubble. What happens in the US economy and in US markets has a large impact on many Australian companies, whether they have direct operations in the US or not.
Investors bidding up ASX 200 shares are following the exuberance in US markets, largely based on Powell's indication that the Fed will eventually be winding back the pace of its interest rate hikes.
According to Ed Moya, senior market analyst at Oanda (courtesy of Bloomberg), "It seems traders aren't thinking another large move will be justified in September."
Despite the rally in ASX 200 shares and US equities, caution remains in order
Despite the strong rally in ASX 200 shares and US equities, economists aren't quite as bullish on Powell's comments as traders.
According to a panel of Bloomberg economists:
While many are worried that the economy is verging on recession, Fed officials see the glass as half full, with the strong labour market allowing the economy to withstand rapid monetary tightening. Bloomberg Economics thinks there's little chance that the Fed will pause its rate hikes later this year, as markets currently expect.
Analysts at NatWest Markets said:
The markets clearly think the net of today is that the Fed will end up doing less tightening, but it was hard to come away from the Fed press conference thinking the Fed delivered a dovish pivot.
If anything, based on what we heard today, the median Fed member's view on the path of the Fed funds rate over the remainder of this year could conceivably be higher.
What happens with inflation in the US and the rest of the world remains to be seen.
But at the moment investors are sending ASX 200 shares sharply higher.
