After two intense days of meetings, the Fed has decided to raise interest rates by 50 basis points to a target range of between 0.75% and 1%, the largest rate hike since the beginning of the century. Since 2000 rate hikes have always been in the 25 bp range. On top of this, the Fed has announced that balance sheet reduction will begin in June with $47.5 billion per month and increase to $95 billion after three months.
We have received the firs reactions from the asset management industry, with the insights from DWS, MIFL, Fidelity, PIMCO, Federated Hermes, Generali Investments , Schroders, Janus Henderson and Ostrum AM.
Christian Scherrmann, U.S. Economist, DWS
The Fed delivered exactly what officials telegraphed ahead of the May FOMC meeting. The federal funds target range was increased to 0.75 to 1.0 percent – a 50bps hike – and the running down of the balance sheet will start as soon as June, with an initial 47.5 billion US Dollar a month – precisely half of what the final pace will be.
Perhaps most significant, however, is that the decision was supported by all FOMC voting members, including those who speculated publicly on the possibility of rate increases in excess of 50 basis points. This implies that even the most hawkish voters do not see the need for an even more front-loaded approach right now and that the verbal guidance, given ahead of the meeting, have pushed market expectations into line with the FOMC’s current view on the likely future path of policy rates. Powell himself suggested in the press conference that 50 basis point hikes “are on the table” for the next meetings.
But one thing that could change this assessment are further surprises in already “much too high” inflation, to which the central bankers are, Powell said, “highly attentive”. Looking into 2023, we expect that growth concerns will be something else to which the Fed will have to be highly attentive. For now, however, it seems that officials are fine with the pace of the economy. Powell attested that “the underlying momentum remains strong” and labor markets “extremely tight”.
Russia’s invasion of Ukraine, Covid lockdowns in China and serious ongoing supply constraints mean that the outlook remains extremely uncertain. And therefore, despite the straightforward communication, investors should be aware, too, that the path of rates remains far from certain.
Brian O’ Reilly, Head of Strategy at MIFL
As expected the FOMC (Federal Open Market Committee) raised the Fed fund rate by 50 basis points to a range of 0.75-1% at its May meeting. This was the largest single rate hike in two decades. In the accompanying communique the Fed also confirmed that it will reduce its $9 trillion balance sheet starting on June 1.
This balance sheet wind-down will start at $47.5 billion and rise to $95 billion a month after three months.
Investors will breathe a sigh of relief that the move was not more aggressive as a 75 basis point hike was hinted at by some of the more hawkish committee members in recent weeks. Investors will continue to monitor Fed comments closely to see if they change their more hawkish tone. However with inflation already at 8.5%, and no end in sight of higher prices being passed onto end consumers Jerome Powell has a difficult job to convince the market that they can engineering both lower inflation and a soft landing, without triggering a recession.
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International
As expected, the Fed hiked rates by 50 basis points today and announced its quantitative tightening program. The overall tone was hawkish, but critically, Chair Powell ruled out scope for 75 basis point hikes for now. Further 50 basis point hikes remain on the table over the next two meetings.
This is the most aggressive move since 2000, but Fed hawkishness has been building into this meeting. We continue to think that, ultimately, the fed will hike less than market expectations, but for now the hawkish stance is likely to remain intact given the strong state of the labour market and inflationary dynamics.
The Fed committed a policy mistake last year by letting inflation run out of control, and as a result, it could be walking a narrow road for some time as it looks to balance the tightening path without creating an accidental recession. When it comes to asset allocation, we remain cautious given the overall hostile Fed stance.
Allison Boxer, US Economist at PIMCO
The Federal Reserve managed to deliver the largest rate hike since 2000 while at the same time surprising market expectations somewhat on the dovish side. The main news from the press conference was that Powell pushed back on the 75 basis point hikes that markets had started to price in.
While the statement focused only on inflation risks and Powell underscored that the Fed is squarely focused on getting inflation back to target, he also acknowledged that the Fed needs to be nimble as it navigates incoming data. This is consistent with our view that an “expeditious” pace of rate hikes will continue as the Fed uses the summer to quickly reverse pandemic era rate cuts, but ultimately will need to be “nimble” in navigating downside risks to growth.
Silvia Dall’Angelo, Senior Economist at Federated Hermes Ltd
Yesterday’s Fed meeting had a distinctively hawkish tone. As almost unanimously expected, the Fed increased its target rate range by 0.5% to 0.75-1% – the largest interest rate increase in 20 years – and announced the start of Quantitative Tightening next month.
Moreover, Powell conveyed a sense of urgency with respect to addressing high inflation, stressing inflation is running “much too high” and reiterating the Federal Open Markets Committee is “highly attentive to inflation risks”, a sentence that also appeared in today’s statement. Accordingly, he said that 0.5% moves are on the table for the next couple of meetings, reinforcing the forward guidance included in the statement in a hawkish way.
The Fed is squarely focused on inflation and determined to bring it under control, rescuing its credibility in the process. The Fed will probably try to bring its policy rate to neutral in short order and likely in restrictive territory by the end of the year. Amid extreme uncertainty about the level of neutral itself – the Fed will likely adopt an iterative process and find neutral along its tightening path.
While Powell reiterated his belief there is a decent chance of achieving a soft (or softish) landing, they rarely happen. It will be difficult for the Fed to calibrate the right amount of tightening, given it is starting from behind the curve. There is uncertainty about structural trends in the economy after the pandemic and monetary policy works with variable lags.
The Fed will likely continue to hike aggressively in the next few months, as inflation could remain sticky at uncomfortably high levels despite having probably peaked. While the labour market is strong and balance sheets are in good shape, it is unclear how the US consumer will weather multiple hits from monetary and fiscal tightening, cost-push inflation squeezing real incomes, and a weaker equity market.
In addition, the US is not in a vacuum and developments outside it will feed into the Fed’s reaction function. The US is the main economy within a deeply interconnected global economy, and the Fed and US dollar play a key role for global financial conditions. Higher US rates and a strong dollar imply tighter financial conditions globally, especially for emerging markets, where foreign-currency-denominated, short-term, floating-rate debt is predominant. Much higher Fed rates could have vicious, far-reaching implications in a highly-indebted world in the wake of Covid and with an ongoing war.
Paolo Zanghieri, senior economist at Generali Investments
The expected 50bp rate rise and the announcement of the balance sheet reduction materialised, as the Fed con-tinues to highlight the risk of higher inflation and remains confident on the strength of domestic demand and the labour market.
With the lowest employment rate in five decades, strong wage growth and nearly two job openings per unemployed per person, the Fed is reasonably confident to be able to cool down inflation without harming the economy. It will therefore move quickly rates to the neutral level (2% to 3%) and then will decide whether to tighten further. A 50 bps hike is to be expected in both June and July.
Quantitative tightening will begin on June 1 and will reach full speed (a monthly reduction of US$ 60 in Treasuries and US$ 35bn of MBS) after three months. We expect the balance sheet to reach its long-term value by mid- 2025.
Markets were relieved by the exclusion of 75bps rate hikes, and the expected policy rate at the end of the year was revised sharply down to 2.8%. Stock prices rose to the highest reading in the week. Given our below consen-sus forecast for growth this year we expect the policy rate to peak at around 2.6% at the beginning of 2023.
Keith Wade, Chief Economist & Strategist at Schroders
We expect the FOMC to further tighten monetary policy at upcoming meetings. However, with the annual rate of consumer inflation at the highest level in four decades, there are concerns that recession will be the counterpart to price stability. Indeed, our analysis suggests that a recession may be an inevitable trade-off to achieve lower inflation, despite hopes of a “soft landing” for the economy.
Essentially, the Central Bank has to restore the balance between supply and demand so that there is sufficient room for manoeuvre in the economy to alleviate wage and price pressures. To achieve a soft landing, this has to be done gradually, with a below-trend growth rate, rather than going into recession with falling output and rapidly rising unemployment. However, this is easier said than done.
A 50 bps increase in the main policy rate would be the largest move at an FOMC meeting since 2000. The federal funds rate, however, would still be below the “equilibrium” level most committee members view as consistent with a neutral central bank policy.
Past experience shows the recessions of the 1980s and 1990s followed a similar pick up in inflation to that being experienced today. While there was much talk of achieving a soft landing during these periods, this was not to be.
Jason England, Portfolio Manager at Janus Henderson
If Wednesday’s announcement by the Federal Reserve (Fed) proved anything, it is that the U.S. central bank continues to prioritize forward guidance in signaling the future path of monetary policy to reassure financial markets that its hands remain firmly on the tiller during a period of considerable economic uncertainty. After its botched call on transitory inflation, Chairman Jerome Powell and company have their work cut out for them.
As had been telegraphed, the Fed raised its benchmark policy rate by 50 basis points (bps) for the first time in over two decades. Not much else can create a sense of urgency than 8.5% year-over-year inflation. Despite this move, we still believe that the Fed – and other central banks – have yet to reach peak hawkishness. This current bout of inflation, in our view, has too many unpredictable sources to simply be placed back in the bottle by raising policy rates in a circumspect manner. Pandemic-related supply dislocations, a growing economy, accelerating deglobalization, the war in Ukraine and the historic amount of liquidity created out of thin air by the world’s central banks to cushion the blow of what turned out to be the short-lived recession have all contributed to the historic run up in prices across much of the global economy.
In his comments, Chairman Powell acknowledged as much and set the table for pulling forward even more of its normalization program. Among these are likely two more 50 bps rate hikes and the rapid ramping up of balance sheet reduction – ultimately topping out at $95 billion monthly – by not reinvesting maturing Treasury and mortgage securities. This is not to say that the Fed has changed its final destination. At its March meeting, after all, it actually lowered its expectation for the neutral policy rate from 2.5% to 2.375%. But given the lagging effect of monetary policy along with inflation at multi-decade highs, we believe the Fed has made the right call by pulling forward normalization and then closely monitoring data over the latter half of the year to watch how prices and economic growth evolve.
Evidence, thus far, is that the Fed’s about face over the past few months is finding receptive ears in financial markets. We see that, foremost, in a flattening yield curve. Over the course of 2022, the yield on the 2-year U.S. Treasury has risen 191 bps to 2.64% (after Wednesday’s fall in yields) as the market priced in near-term policy rate increases. Meanwhile, the yield on the 10-year has climbed by less dramatic 141 bps, to 2.92%. We interpret this as the market seeing the Fed having a fighting chance in piloting the U.S. economy toward a soft landing. If the Fed had lost all credibility with investors, we’d likely be seeing a spread between 10-year and 2-year Treasury yields at a level higher than the current 28 bps. Other market-based data send the same message. Inflation expectations based on Treasury Inflation Protection Securities (TIPS) have fallen from 3.73% in late March to 3.24%. Over a 10-year horizon, TIPS imply a 2.88% annual average, again, off its recent peak. Of note: both rose slightly post the Fed announcement.
The flattening yield curve has changed the landscape for bond investors. While higher yields on shorter-dated maturities may be a welcome development for those who have long awaited the chance to generate higher returns on more liquid instruments, the absence of what we consider an appropriate term premium on longer-dated Treasuries reduces the allure of these securities at present. This is especially true given the current elevated level of inflation whose ingredients include sources that may not be responsive to higher policy rates.
Axel Botte, Global Strategist at Ostrum AM
The Fed raised rates by 50 bp to 1%, the largest increase at one meeting since 2000. There will be at least two additional 50 bp moves in June and July. During the press conference, Fed Chair Jerome Powell addressed the American people (which is unusual) and committed to do “what it takes” to bring inflation down.
This may hint at a change in the long-standing market-friendly Fed policy. Powell is indeed walking a fine line in the sense that rates will have to continue to rise amid 8% inflation but achieving a soft-landing in the economy and avoiding undue tightening of financial conditions will be hard to achieve. Hence, Powell ruled out 75 bp hikes for instance, which helped risky assets moved higher (S&P 500 gained 3% yesterday). So, whilst the Fed talks hawkish between meetings, it does act slightly more dovish than expectations to smooth out the market’s knee-jerk reactions.
As concerns the balance sheet policy, the Fed announced that it will stop reinvesting $ 30 Bn worth of Treasuries and $ 17.5 Bn MBS starting June 1st. The phase-in period will run until the end of August. From September, monthly caps will double to $ 60 Bn. The balance sheet contraction is more gradual than expected following the release of the March FOMC minutes. Again, Jerome Powell used his leeway to err on the slightly dovish side. The hard questions pertaining to the overall QT envelope and the potential outright sales of MBS to rebalance the portfolio into a greater share of Treasuries was dodged. Understandably”