Today and tomorrow the members of the Fed’s Federal Open Market Committee (FOMC) will meet. This is undoubtedly one of the most decisive meetings of the year, as expectations for interest rate hikes have been changing over the last few weeks. In fact, Fed Chairman Jerome Powell said on the 21st of April that a 50 basis point hike would probably be considered at the next meeting in May.
What does the asset management industry expect from Powell’s decision? These are their thoughts.
Franck Dixmier Global CIO Fixed Income at Allianz GI
Despite constant upward surprises on inflation over the past year, the US Federal Reserve has so far shown no sense of urgency. Asset purchases were only stopped in March, and it was only at its last meeting that the Fed initiated a first, modest inflection of Fed Funds rates with a 25-basis-point increase.
However, the latest inflation figures for March marked new highs, with the consumer price index (CPI) at +8.5% in March compared to +2.6% just one year ago. This data reinforced the perception that the Fed has fallen behind in normalising its monetary policy.
Therefore, it’s time for the Fed to act quickly and strongly in an effort to make up for lost time.
After Jerome Powell’s mea culpa acknowledgment that the Fed should have acted sooner, it is back to basics for the members of the Federal Open Market Committee (FOMC), with price stability as their overriding objective. Their most recent and resolutely hawkish comments leave no doubt about the next meeting on 3 and 4 May: the Fed is expected to announce a 50-basis-point rate hike and a reduction in the size of its balance sheet from June.
However, the challenge in implementing its monetary policy normalisation will be to ensure a soft landing for the US economy while maintaining a dynamic labour market and, above all, avoiding a recession.
The -1.4% annualised contraction in US GDP in Q1 should be analysed carefully. It reflects a rise in imports and a fall in exports, while household consumption is still robust, at +2.7% annualised in Q1. However, these figures illustrate the challenge confronting the Fed: high inflation at the same time as an increased probability of the US economy entering a recession over a 12-to-18-month horizon.
In this trade-off between achieving its price stability objective and the potential risk of a sharp slowdown, it seems unlikely that the Fed will sacrifice US growth. That’s the bet markets are currently making. While expectations on short-term rates have recently adjusted to reflect this desire to raise rates very quickly with 50 basis point increases predicted over the next three meetings, it is interesting to note that medium and long-term inflation expectations have remained at high levels, well above the 2% target. For the markets, the 2% price stability objective is not realistic without plunging the US economy into recession.
This pragmatic approach, under which the Fed would halt its rate hikes to avoid weighing too negatively on activity, remains a delicate balance. The high degree of uncertainty about future inflation shocks, linked in particular to the rise in commodity and energy prices, makes the forecasting exercise difficult and is likely to keep volatility high in interest rate markets.
In his press conference, Jerome Powell should not contradict market expectations while insisting on the flexibility required to achieve the price stability objective. The time to act is now.
Allison Boxer, US Economist at PIMCO
The Fed will start its “expeditious” effort to remove monetary policy accommodation this week as they hike the fed funds rate 50bps, the largest rate increase since 2000, and announce a plan for balance sheet runoff.
Fed officials have pivoted significantly more hawkish since the last FOMC meeting, and endorsed a front-loading of monetary policy tightening amidst ongoing inflation risks.
Given the strongly hawkish communication and detailed balance sheet preferences provided ahead of this meeting, we think the policy decisions will leave little surprise for market participants. Instead, all eyes will be on guidance in the statement and press conference for any hints on the speed ahead.
With the Fed’s preferred inflation measure printing above 5% in 1Q and a notable continued absence of mentions of downside risks in recent Fedspeak, we expect the Fed to remain on course for another 50bp hike in June. However, the contraction in 1Q real GDP was a reminder of the bumpy path “reopening and rebalancing” the economy is likely to take. After “expeditiously” reversing pandemic-era rate cuts and getting balance sheet rolloff underway, we still ultimately look for a slower pace of policy tightening as global growth slows and “stuff happens” along the way.
François Rimeu, Senior Strategist, La Française AM
After a cautious 25 bps increase in the Fed Funds Rate at its March meeting, it is expected that the Federal Open Market Committee (FOMC) will hike rates by 50 bps to fight against inflation at its May 3-4 meeting. In addition, Federal Reserve Chair Powell should announce officially the balance sheet runoff plan.
Please find below what we expect:
- The FOMC to raise the Federal Funds Target Range to 0.75-1.0%. Chair Powell will signal willingness to hike rates by another 50 bps at one or more upcoming meetings, because inflationary pressures remain strong, and the labor market is ‘extremely tight’. We believe Chair Powell will not rule out a larger rate increase (i.e., a 75 bps hike) if needed, even if it is not on the table at this stage. He will underline that the pace of policy tightening will be data dependent.
- Federal Reserve Chair Powell to reaffirm the need to move “expeditiously” to bring the Fed Funds Rate to a more neutral level (2.25-2.50%); the degree of overshoot will depend on the inflation outlook.
- The Fed to announce quantitative tightening by no longer reinvesting the principal payments received from its securities holding. According to the March FOMC minutes, the process will involve a maximum monthly cap of $95bn ($60bn for treasuries and $35bn for mortgage-backed securities) with caps phased in “over a period of three months or modestly longer if market conditions warrant”. We expect runoff to start in June.
We expect the FED to maintain its hawkish tone despite ongoing risks (i.e., China’s strict Zero-Covid policy, the war in Ukraine). This meeting may push US interest rates higher.
Paolo Zanghieri, Senior Economist, Generali Investments and Florian Späte, Senior Bond Strategist, Generali Investments
With sustained wage pressures (the Atlanta Fed media wage measure was up by 6% yoy in March), and likely second round effects from high commodity prices, core inflation will not end the year below 4% yoy.
We expect the Fed to respond with a 50 bps hike in each of the next two meetings. A faster tightening before the end of the summer is possible; afterwards we see a less steep path than what markets price, with the policy rate peaking at 2.7% (versus 3.2% implied by forwards), as the weakening of the economy in H2 will eventually require more caution. Still, the path will be among the steepest in the last forty years.
Financial markets expect the Fed to raise key rates by another more than 230 bps in 2022. Next year further hikes are discounted.
However, we think a peak well above 3.0% looks exaggerated as markets do not take sufficient account of the growth slowdown triggered by the tightening of financial conditions. Given our below growth forecasts for 2022 and 2023 (2.7% vs. 3.3% and 2.1% vs. 2.4%) we forecast the upper bound of the band to not exceed 2.75%.