Latest Fed statements… Brainard announced that the Fed’s total assets of 9 trillion dollars will decrease rapidly compared to previous periods. According to Brainard, the balance sheet cuts will contribute to the planned tightening of the Fed’s interest rate projections in members’ assumptions. Brainard was seen by Fed commentators as a dovish member.
Esther George, the more hawkish Kansas City Fed chair, also thinks the tightening dose could be increased. George said that besides the balance sheet discussions, a 50 basis point rate hike should also be discussed as an option.
Money market expectations and balance sheet reduction… Money markets are pricing in the Fed’s 225 basis point rate hike expectations for the remainder of this year. If this expectation is met with the increase in March, the Fed will close 2022 with a 2.5% rate hike. The last time the Fed raised interest rates this high in a year was 1994. Before 1994, such a tightening was last seen in the early 1980s under Paul Volcker.
If priced expectations are met, the upper band of the Fed’s interest rate range will reach 2.75%. This level was last reached during the 2008 financial crisis. Beyond rate hikes, the Fed has other tools at its disposal. The balance sheet contraction also functions as a monetary tightening. The details revealed in the minutes indicate that a balance sheet reduction statement may come at the next meeting to be held on May 3-4.
Current rate pricing of Fed future funds… Source. Bloomberg, CME Fedwatch
Conclusion? The FOMC has become increasingly hawkish in a climate of perpetually high inflation, and the most pressing question is whether policymakers can return inflation to target without undermining economic growth. Despite all these findings; A temporary inversion of the yield curve is a sign that the bond market has lost faith in a soft landing. While the Fed certainly pays close attention to labor market developments, it is more focused on reining in high inflation.
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