Fed Review: Belly Laugh

Summary

• As widely expected, the Fed hiked 25bps at the policy meeting on Wednesday.
• The meeting provided limited new information on the policy path or the Fed’s economic views.
• The Fed remains focused on core services ex-shelter inflation, which it does not think has turned yet.

Market Implications

• Markets remain far apart from the Fed on inflation and the FFR. 
• They now see the Fed as more dovish than the ECB and BoJ, which is driving the dollar and the belly of the curve lower.

Powell Sticks to the December SEP

The Fed hiked the federal funds rate (FFR) by 25bps to 4.5-4.75% at Wednesday’s policy meeting. Widely expected, the downshift follows a 50bp hike in December and four 75bp hikes before that.

As I expected, Chair Jerome Powell provided limited new information on the Fed’s next moves. He confirmed that a ‘couple more’ increases in the federal funds fate (FFR) were coming. He further specified that if the economy proceeded as the Fed expects, as in the December Summary of Economic Projections (SEP), there would be no cause for rate cuts in 2022.

Powell did not answer questions on when the Fed might pause. Rather, he indicated that the FOMC macroeconomic forecast would be updated through the SEP at the March meeting.

He stressed that more data was needed to be confident that inflation was on a sustainable downward path but avoided providing a timeframe. 

Powell acknowledged the progress on core goods inflation and said there was good cause to expect shelter inflation to moderate. However, he stressed that non-shelter core services inflation had yet to turn (Chart 1). The latter would likely require an easing of the labour market.

He added that the economic costs of tightening too little were higher than the economic costs of tightening too much because the latter could be more easily be addressed through policy changes.

Market Consequences

As we expected, Powell did not get market pricing nearer the December SEP’s end-2023 FFR at 5.1%. Instead, markets reacted to the presser by shaving about 4bp from the June 2023 FFR and 10bp from the December 2023 FFR. The end-2023 FFR priced by the market remains about 70bp below the Fed.   

The market is trading on the assumption that the Fed is close to pausing.

It is now treating the Fed as dovish relative to ECB and BOJ outlook, driving the dollar lower. And the lower dollar is pushing the belly of yield curve, especially the TIPs, lower.

This is bullish for US risk assets such MBS, high grade credit and equities. 

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

Mustafa Chowdhury comes with over 30 years of experience in the industry. He has held senior positions at several leading firms, including Voya Investments (formerly ING US), Deutsche Bank, Bear Stearns and Freddie Mac. He has a wealth of knowledge and expertise in trading, research, and portfolio management of G-10 Macro Rates, MBS and Derivatives.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)