Central bank

The Fed's Hawkish Hike

17 March 2022 • 3 mins read
The Fed's Hawkish Hike
  • Overnight, the Federal Reserve raised its fed funds rate for the first time since 2018 by 25bps to 0.25-0.50% to counter rising inflation, and gave a more hawkish outlook for interest rates.
  • The Federal Open Market Committee revised its forecasts and now expects seven 25bps rate hikes this year and three-to-four in 2023, lifting the fed funds rate to 2.75% next year.
  • Chairman Powell also didn’t rule out 50bps hikes in future and hinted the Fed could start quantitative tightening (QT) as early as May.
  • We thus change our forecasts and see the Fed hiking seven times this year while keeping our view of four rate rises in 2023. We also expect the Fed will announce its plans for QT in May.

Overnight, the Federal Reserve increased its fed funds rate for the first time since 2018 - as expected by 25bps to 0.25-0.50% - to counter rising inflation while giving a more hawkish outlook for interest rates this year and next year.

First, the Federal Open Market Committee warned ‘ongoing increases in the target range will be appropriate’ for the fed funds rate now.

One member, St. Louis Fed President Bullard, voted for a 50bps rate hike at the FOMC meeting. Further, Chairman Powell didn’t rule out 50bps increases in future if core inflation, currently above 6% for the consumer price index (CPI) doesn’t start returning to the Fed’s 2% goal.

Second, the FOMC revised its forecasts for interest rates significantly higher, implying that Fed hikes will be front loaded in 2022 and 2023 to bring inflation back towards its 2% target in 2024.

The median FOMC projection now anticipates seven 25bps rate rises this year - increasing interest rates further at each of the Fed’s remaining six meetings of the year - and another three-to-four 25bps hikes in 2023. This would bring the fed funds rate up to 2.75% by the end of next year. It would thus exceed the FOMC’s estimate of the long-run neutral level for fed funds at 2.25-2.50%, implying officials are aiming to make monetary policy restrictive to lower inflation.

Third, the FOMC shifted its economic forecasts.

Fed funds rate

Source: Bank of Singapore, Bloomberg.

Policymakers cut their estimates of GDP growth this year from 4.0% to 2.8%, in part due to the oil shock from Russia’s war with Ukraine, while raising forecasts for core inflation to 4.1% in 2022, 2.6% in 2023 and 2.3% in 2024. Thus, inflation is still seen exceeding the Fed’s 2% target in two years’ time.

Fourth, Powell signalled the Fed could give its plans for unwinding its pandemic quantitative easing as early as May. Reducing its balance sheet would also help lower inflationary pressure.

Given the Fed’s determination to cut inflation, we change our forecasts and now see seven hikes this year (from five increases before) while keeping our view of four hikes in 2023. This implies:

  • we see the fed funds interest rate reaching 2.75-3.00% by the end of next year, a steeper path of tightening to our previous forecasts.
  • our 10Y Treasury yield forecast at 2.35% over the next 12 months is now likely to be hit earlier so we will revise our estimates for Treasury yields and swap rates this week.
  • higher yields are a headwind for investors but 10Y Treasuries would need to breach 2.80-3.00% for the decades-long downtrend in yields to reverse to the detriment of risk assets.
  • yield curves are likely to flatten further and may invert temporarily but reopening from the pandemic will keep US growth firm and reduce the risks of stagflation this year.
  • Last, the USD will benefit from the Fed hiking faster compared to other central banks.

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Author:
Mansoor Mohi-uddin
Chief Economist
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