US Federal Reserve Board Chairman Jerome Powell spoke during his hearing for re-nomination to the Senate Committee on Banking, Housing and Urban Affairs on Capitol Hill, Washington, USA, January 11, 2022.
Graham Jennings Reuters
The Federal Reserve is expected to raise its federal fund interest rate by half a percentage point on Wednesday, but investors will be more focused on whether it signals it could become even more aggressive with future interest rate hikes.
The Fed is also expected to announce a program to reduce its balance sheet of approximately $ 9 trillion by $ 95 billion a month, starting in June. The increase of 50 basis points will set the target range of interest rates of federal funds from 0.75% to 1%.
This target interest rate for federal funds after the increase this week would be much lower than zero, but well below market expectations for interest rates above 2.8% by the end of this year.
Central bank communications will be key, given the slowdown in some economic data while inflation is still hot. Economic growth slowed by 1.4% in the first quarter, but economists say it is distorted by trade data and expect gross domestic product to recover in the second quarter.
“I think they will be 50 [basis points]and they seem to be determined to raise interest rates enough to kill inflation, “said Jim Karen, chief fixed income strategist at Morgan Stanley Investment Management’s global fixed income team.” But this is the real debate. Are they trying to reach the inflation target by 2024? If they are, wage inflation is quite high and this will require even more tightening than the Fed predicts. “
Powell’s comments are up front and center
The Fed’s forecast shows that it expects inflation of basic personal consumer spending to reach 2.3% by 2024 and return to the Fed’s 2% long-term target. Central bank officials also forecast federal fund interest rates of 1.9% for this year and 2.8% for 2023 and 2024 in their March forecasts. The central trend in the Fed’s interest rate forecast for 2023 is between 2.4% and 3.1%.
The central bank is not releasing its next quarterly forecast until the June meeting, so much of what the market will depend on will come from Fed Chairman Jerome Powell. Powell informed the media after the statement was published at 14:00 ET.
The futures market sets federal fund interest rate pricing at 2.82% by the end of this year, which will take approximately a 2.5 percentage point increase in 2022. Traders are betting an increase of 50 basis points this week, as well as closing until 50 or more for each of the next three meetings in June, July and September.
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St. Louis Federal Reserve
“The cross winds are so strong. I think the main question is clear. Just how fast is inflation falling or is the Fed accelerating the tightening over the next four to five months?” said Michael Schumacher of Wells Fargo.
Consumer price inflation jumped 8.5% in March. Although economists say inflation could peak, how quickly it will fall will be the key to the Fed’s interest rate path.
“The Fed will have to look at the situation and say that inflation is off, it’s falling. Is it falling fast enough?” said Schumacher.
“Many politicians say they want to reach a neutral position by the end of this year – 2.50% plus, and the Fed’s market price is above neutral – 3.30% by the middle of next year. It’s too low, I think. “There are a lot of people who say that funded funds need to be raised much higher,” he added.
The Fed’s next steps became a focal point
Strategists say markets are preparing for the Hawk Fed. However, if the central bank provides what is expected without emphasizing more aggressive tourism, this can be seen as a dove. This means that bond yields, which are moving against the price, may fall after the meeting and stocks may move higher.
“What he really cares about in the market is the prospect of increases, and especially the possibility of 75 basis points,” said Mark Cabana, head of US interest rate strategy at Bank of America. Traders speculate that the Fed may raise the rate with an even greater increase in interest rates at the meeting in June.
JPMorgan economists said there was a 1-on-5 Fed chance of raising interest rates by 75 basis points this week, although the market did not appreciate the opportunity.
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Although the Fed is not expected to provide much clarity on the pace of its rise, Powell may be asked about it during his briefing.
“He will not support or reject the idea of 75,” Kabana said. The chairman will probably follow the scenario from the last meeting, when the Fed raised interest rates by a quarter. This was the first rise since 2018.
“We think he will try to be as non-committal as possible, similar to what he said last time,” Kabana said.
Communication intention
Rick Ryder, BlackRock’s chief investment officer for global fixed income, said he expects the Fed to raise interest rates by half a percentage point on Wednesday, but at some point in the future the central bank could accelerate its rise if it feels needed to neutral. -fast.
If the Fed made clear its intention, markets could tighten faster. “They could pick up the pace and go faster, and then they can turn,” he said.
After the last meeting, the outlook for the economy deteriorated and the markets caused hysteria. Fed officials have been far more outspoken about their determination to fight inflation by raising interest rates, and this injects more fear of economic downturns.
Reeder said he does not predict a recession this year because the economy is too strong. “I don’t think we’re going into a short-term recession. The data is still solid,” he said. But Reeder added that it is slowing down and there may be a recession in 2023. “I think any recession we see in the next few years will be shallow unless there is exogenous shock.”
The S&P 500 fell 8.8% in April, while bond yields rose. 10-year government bond yields rose well above 3% this week, from 1.66% in the week before the Fed’s last meeting in March. The 10-year-old was at 2.95% on Tuesday.
Strategists do not expect the Fed to be concerned about either the sale of the stock market or the increase in bond yields. “They want to tighten financial conditions. That’s part of the story,” Kabana said. He expects Powell to say that the tightening was not unexpected.
“He will say the economy is still strong and the Fed’s price recovery is paramount,” Kabana said. Powell is also likely to insist that the Fed sees a soft landing for the economy, although the market will remain skeptical, he added.
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