May 20, 2022

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The Fed is expected to increase the interest rate by half a point;  Investors on the brink

The Fed is expected to increase the interest rate by half a point; Investors on the brink

US Federal Reserve Chairman Jerome Powell speaks during his re-nomination hearing for the Senate Committee on Banking, Housing, and Urban Affairs on Capitol Hill, in Washington, US, January 11, 2022.

Graeme Jennings | Reuters

The Federal Reserve is widely expected to raise the federal funds target rate by half a percentage point on Wednesday, but investors will be more focused on whether it indicates it could get tougher with future rate hikes.

The Fed is also expected to announce the start of a program to wind down its roughly $9 trillion balance sheet by $95 billion per month, starting in June. A 50 basis point hike would put the fed funds rate range at 0.75% to 1%. The base point is 0.01%.

That target rate after the consolidation this week would be far from zero, but well below market expectations of a higher interest rate of 2.8% by the end of the year.

Wednesday’s central bank communications will be key, given the slowdown in some data while inflation remains hot. Economic growth contracted by 1.4% in the first quarter, But economists say trade data is distorted, and they expect GDP to rebound in the second quarter.

“I think they will reach 50 [basis points]They seem to have died intent on raising rates enough to kill inflation, said Jim Caron, chief fixed income strategist on the global fixed income team at Morgan Stanley Investment Management. “But this is the real debate. Are they trying to reach their inflation target by 2024? If so, wage inflation is very high and that will require more tightening than the Fed expects.”

Powell comments front and center

The Fed’s forecast shows that it expects Core PCE inflation To reach 2.3% by 2024 and return to the Fed’s long-term target of 2%. Central bank officials also projected a fed funds rate of 1.9% for this year and 2.8% for 2023 and 2024 in their March forecasts. The central trend of the money market rate for 2023 ranged between 2.4% and 3.1%.

The central bank doesn’t release its next quarterly forecast until the June meeting, so much of what the market will depend on will come from Fed Chair Jerome Powell. Powell will brief the media on the statement after 2 p.m. EST.

The futures market is pricing the fed funds rate at 2.82% by the end of this year, which could take roughly 2.5 percentage points of hiking in 2022. Traders are betting 50 basis points higher this week, as well as closing to 50 or more for each meeting of The next three meetings are in June, July and September.

Federal Reserve in St. Louis

“Crosswind is very difficult. I think the fundamental question is clear. It’s just how fast is inflation going down or is the Fed accelerating the tightening process in the next four to five months?” said Michael Schumacher, Wells Fargo rates strategy director.

Consumer price inflation jumped 8.5%n March. While economists say inflation may be at its peak, the speed of its decline will be key to the Fed’s interest rate trajectory.

“The Fed is going to have to look at the situation and say inflation has stopped, it is going down. Is it going down fast enough?” Schumacher said.

“A lot of policy makers say they want to be neutral by the end of this year – 2.50% plus, and the market is priced to have the Fed above neutral – 3.30% by the middle of next year. That’s too low I think a lot of people are saying that The federal money has to go much higher.”

The Fed’s next steps have become the focal point

Strategists say markets are preparing for a hawkish Fed. However, if the central bank delivers what is expected without emphasizing more aggressive walking, it may be seen as pessimistic. This means that bond yields, which move opposite the price, can go down after the meeting and stocks can go up.

“What the market will really care about is the expectations for hikes and especially the possibility of 75 basis points,” said Mark Cabana, head of short rate strategy at Bank of America. Traders were speculating that policy makers could raise the bet with a larger rate hike at the June meeting.

Economists at JPMorgan said there is a one in five chance that the Fed will raise interest rates by 75 basis points this week, although the market is not pricing that possibility.

While the Fed is not expected to provide much clarity on the pace of its hike, Powell can be asked about it during his briefing.

“He will neither support nor reject the idea of ​​the 75,” Cabana said. Instead, Powell is likely to follow the scenario from the last meeting, when the Fed raised interest rates by a quarter point. This was the first rise since 2018.

“We think he’s going to try to be as non-committal as possible, similar to how he looked last time,” Cabana said.

Communicate the intent

Rick Rieder, chief investment officer for global fixed income at BlackRock, said he expects the Fed to raise interest rates by half a percentage point on Wednesday, adding that at some point in the future, it can speed up the rate hike if it feels the need to. . Get neutral faster.

If the Fed clearly communicates its intention, markets may take quick tightening action. “They can pick up the pace and go faster, and then they can pivot,” he said.

Since the last meeting, the outlook for the economy has deteriorated and the markets have thrown a tantrum. Fed officials have been more vocal about their determination to fight inflation by raising interest rates, and that is what has happened Injecting more fear of an economic downturn into the markets.

Reeder said he does not expect a recession this year because the economy is so strong. “I don’t think we are going into any recession in the near term,” he said. “The data is still strong.” But Reeder added that it is slowing down, and there could be a recession in 2023. “I think any recession we see in the next two years will be superficial unless there is an external shock.”

The Standard & Poor’s 500 It fell 8.8% in the month of April, while bond yields rose. The 10 years treasury Yield hit a Up 3% this week, while it was at 1.66% in the week before the last Fed meeting in March. The 10-year ratio was 2.95% on Tuesday.

Strategists do not expect the Federal Reserve to be concerned about a massive sell-off in the stock market or a rise in bond yields. “They want to tighten financial conditions. That’s part of the story,” Cabana said. Powell is expected to say the tightening was not unexpected.

“He will say the economy is still strong, and that the Fed’s reset on rates is critical,” Cabana said. He added that Powell is also likely to stress that the Fed sees a soft landing in the economy, although the market will remain skeptical.

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