The Fed is expected to raise interest rates by half a point. Investors are wondering if it will become more aggressive

The US Federal Reserve Chairman Jerome Powell speaks during his nomination hearing of the Senate Banking, Housing and City Committee on Capitol Hill, Washington, USA, January 11, 2022.

Graeme Jennings | Reuters

The Federal Reserve is generally expected to raise its target interest rate by half a percentage point on Wednesday, but investors will be more focused on whether it signals that it may become even more aggressive with future interest rate increases.

The Fed is also expected to announce the start of a program to settle its $ 9 trillion balance by $ 95 billion a month, starting in June. The increase of 50 basis points will set the target funds̵[ads1]7; target rates of 0.75% to 1%.

That the Fed funds target interest rate after this week’s increase would be well outside zero, but far below the market’s expectations of a fund interest rate above 2.8% by the end of this year.

The central bank’s communication will be the key, given the decline in some economic data while inflation is still high. Economic growth fell by 1.4% in the first quarter, but economists say it was distorted by trade data and they expect gross domestic product to decline in the second quarter.

“I think they will be 50 [basis points]”And it seems like they’s ready to raise interest rates enough to kill inflation,” said Jim Caron, chief strategist at the global interest rate team at Morgan Stanley Investment Management. “But that’s the real debate. Are they trying to reach the inflation target by 2024? If they are, wage growth is quite high, and it will require even more austerity than the Fed estimates. “

Powell’s comments are central

The Fed’s forecast shows that it expects inflation in core consumption expenditure to reach 2.3% by 2024 and return to the Fed’s target of 2% in the longer term. Central bank officials also estimate an interest rate of 1.9% for this year and 2.8% for 2023 and 2024 in their estimates for March. The central trend in the Fed’s forecast for the fund interest rate for 2023 was between 2.4% and 3.1%.

The central bank will not release its next quarterly forecast before the June meeting, so much of what the market will depend on will come from Fed Chairman Jerome Powell. Powell briefs the media after 2 p.m. ET release of the statement.

The futures market prices a Fed funds rate of 2.82% by the end of this year, which will increase by about 2.5 percentage points in 2022. Traders are betting on a 50 basis point increase this week, in addition to closing at 50 or more for each of the next three meetings in June, July and September.

St. Louis Federal Reserve

“The headwind is so tough. I think the basic question is clear. It’s just how fast inflation is falling, or will the Fed accelerate the tightening over the next four to five months?” in Wells Fargos Michael Schumacher.

Consumer price inflation rose by 8.5 per cent in March. While economists say that inflation may reach its peak, how fast it falls will be the key to the Fed’s interest rate path.

“The Fed must look at the situation and say that inflation is off, it is falling. Is it falling fast enough?” in Schumacher.

“Many decision makers say they want to be neutral by the end of this year – 2.50% plus, and the market is priced for the Fed to be above neutral – 3.30% by the middle of next year. That’s too low I think “There are a lot of people out there who say that feeds have to go much higher,” he added.

The Fed’s next step will be the focal point

Strategists say markets are preparing for a hawkish Fed. But if the central bank delivers what is expected without emphasizing more aggressive hiking, it can be perceived as dove-like. This means that bond yields, which move in opposite directions, may fall after the meeting and equities may move higher.

“What the market is really going to care about is the prospect of gains and especially the possibility of 75 basis points,” said Mark Cabana, head of the US Bank of America’s interest rate strategy. Traders have speculated that the Fed may increase the rate with an even larger interest rate increase at the June meeting.

JPMorgan’s economists said there is a 1 in 5 chance that the Fed will raise interest rates by 75 basis points this week, even if the market does not price that opportunity.

Although the Fed is not expected to provide much clarity about the pace of the hikes, Powell may be asked about it during his briefing.

“He’s not going to support or dismiss the idea of ​​75,” Cabana said. The chairman of the board will probably follow the script from the previous meeting, when the Fed raised the interest rate by a quarter of a point. It was the first hike since 2018.

“We think he’s going to try to be as non-committal as possible, just like he sounded last time,” Cabana said.

Communicate intention

Rick Rieder, BlackRock’s chief investment officer for global bonds, 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 may accelerate the rise if it feels the need to move neutral faster.

If the Fed clearly communicated its intention, markets could tighten faster. “They could accelerate the pace and go faster, and then they could swing,” he said.

Since the last meeting, the outlook for the economy has deteriorated and the markets have experienced tantrums. Fed officials have been far more outspoken about their willingness to fight inflation with rate hikes, and it has injected more fears of an economic downturn in the markets.

Rieder said he does not envisage a recession this year because the economy is too strong. “I do not think we are entering a short-term recession. The data is still solid,” he said. But Rieder added that it is slowing down and that there may be a recession in 2023. “I think any recession we see over the next few years will be shallow unless it is an exogenous shock.”

The S&P 500 fell 8.8% in April, while bond yields shot higher. The 10-year government bond yields hit a high above 3% this week, while it was 1.66% in the week leading up to the last Fed meeting in March. The 10-year was 2.95% on Tuesday.

Strategists do not expect the Fed to be concerned about either the stock market’s sales or the rise in bond yields. “They want to tighten economic conditions. That’s part of the story,” Cabana said. He expects Powell to say that the tightening was not unexpected.

“He wants to say that the economy is still strong and that the Fed’s getting prices back in check is crucial,” Cabana said. Powell is also likely to press for the Fed to see a soft landing for the economy, although the market will remain skeptical, he added.

Source link

Back to top button