ASX 200 marches higher as US Fed holds fire on rate hike. What can investors expect now?

The lift enjoyed by the ASX 200 today may be muted due to some hawkish caveats from Fed chair Jerome Powell and company.

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The S&P/ASX 200 Index (ASX: XJO) is off to a good start on Thursday.

In early morning trade, the benchmark index is up 0.38%.

This comes following a mixed performance in US markets overnight after the US Federal Reserve delivered a much hoped-for pause in its relentless tightening cycle. That leaves the official US rate at 5.00% to 5.25%

Like US markets, however, the lift enjoyed by the ASX 200 today may be muted due to some hawkish caveats from Fed chair Jerome Powell and company.

Why didn't the Fed raise interest rates?

The overnight rate pause by the Fed that's helping boost the ASX 200 today had been broadly priced into the markets, with the majority of analysts forecasting the central bank would hold fire in June.

As we wrote here yesterday, "The latest inflation data out of the US lends some credence to the growing likelihood the ASX 200 won't have to deal with another Fed rate hike tomorrow."

While consensus forecasts don't always get it right, in this case, the majority was spot on.

This marks the first pause from the Fed since the inflation battle began 15 months ago. But before you break out the confetti, Fed officials signalled more rate hikes were likely on the cards for 2023.

According to the Federal Open Market Committee (FOMC), "Holding the target range steady at this meeting allows the committee to assess additional information and its implications for monetary policy."

"We've covered a lot of ground, and the full effects of our tightening have yet to be felt," Powell said following the announcement.

Tempering expectations of any rate cuts from the world's most watched central bank fuelling a rally on the ASX 200, he added, "Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go."

In fact, rather than interest rate cuts, investors would do well to position themselves for further increases.

"It may make sense for rates to move higher, but at a more moderate pace," Powell said.

What might ASX 200 investors expect ahead in 2023?

Whether ASX 200 investors can expect to see additional rate hikes from the Fed this year depends on who you ask.

If you ask Powell and Fed policymakers, the answer is most likely yes.

In fact, as Bloomberg reports, 12 of the 18 policymakers believe the rate will rise to or above 5.5% to 5.75%. That implies a further increase of 0.50% from the current rate.

Investors are also broadly in the additional rate hike camp. 70% of the respondents in Bloomberg's Instant MLIV Pulse survey think the Fed isn't done tightening yet.

And if you're hoping the Fed will offer some end-of-the-year tailwinds to the ASX 200 by beginning to cut rates, the majority of polled investors believe you should put those hopes on hold until next year. Fully 56% don't expect to see any easing from the central bank until at least the second quarter of 2024.

Addressing the potential impacts of that scenario, Josh Gilbert, market analyst at eToro said, "The worry from here is rates staying higher for longer, which could weigh on growth, and put the economy under pressure."

Some positives…

Now if you're looking for some rosier outlooks on how the Fed might impact the performance of ASX 200 shares, you're more likely to get those from economists.

According to Bloomberg economists Anna Wong, Stuart Paul and Eliza Winger:

We interpret this dot plot as a jawboning tool – a way for the Fed to pre-empt further easing in financial conditions in response to its rate pause, even if the additional tightening is unlikely to be fully delivered…

We believe that inflation will likely be lower than these projections by year-end, and ultimately the Fed will hike less than what the new dot plot indicates.

Morgan Stanley's chief economist Ellen Zentner also believes ASX 200 investors have seen the last rate increase from the Fed in the current tightening cycle (courtesy of The Australian Financial Review).

"In the very near term, the bar to a July hike is not insurmountable, but we think would be an Olympic feat," Zentner said.

As for the medium-term outlook, she added:

By the time of the September meeting, the core inflation projection for this year, as well as the level of the funds rate could get revised downward…

Consistent with the economic outlook, we continue to look for the Fed to hold the peak rate at 5.1% for an extended period before making the first 25 basis point cut in March 2024.

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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