US Fed Review: FOMC hikes rates as expected and signals more hikes to come

The Fed’s decision to hike interest rates was by no means a cut-and-dry cause of bullish sentiment. Overall, initial price action certainly seems to imply as much. What came from the central bank, and the subsequent response in markets, illustrates a slightly more mixed, uncertain, and precarious picture. On top of that, as we’ve experienced following recent FOMC meetings, the initial reaction in markets may be more a function of technicals and “buy-the-rumour-sell-the-fact” dynamics, so it’ll be interesting to see how the rest of the week’s trade unfolds.

With all of that said, here are the key takeaways you should know from the decision.

1. The Fed hikes 25 basis points

As was completely baked into rates markets leading into the event, the Fed raised the Federal funds rate by 25 basis points – the first time it has done so since 2018. The decision was made on a 8-1 voting split, with one member, the publicly hawkish St Louis Fed head James Bullard, voting for a 50 basis point hike.

2. SEP upgrades inflation forecasts, downgrades growth

The Statement of Economic Projections showed a marked chance in consensus expectations for the US economy going forward. In response to recent overshoots in inflation data, the Fed upgraded its forecast for the PCE Index in 2022 from 2.6% to 4.3% but downgraded its forecast for GDP growth from 4.0% to 2.8%. Despite this, the Fed expects that the unemployment rate ought to remain low and stable this year and throughout the projection horizon, with the headline jobless rate to fall to 3.5% this year.

3. ‘Dot-plots’ show an aggressive tightening cycle

The median projection for the Federal Funds Rate was increased markedly by the FOMC, implying another 6 rate hikes before the end of 2022 (to around 1.9%), and a rise in the FFR to as high as 2.8% in this cycle. The terminal rate is still thought to be around 2 ½%, meaning the central bank expects to take policy above the notional neutral rate and move policy conditions into contractionary territory in the medium term.

4. The US economy remains ‘resilient’

The initial response from the markets to the Fed’s decision and SEP was bearish. However, sentiment turned during Chairperson Powell’s press conference when the Fed head expressed the ‘resilience’ of the US economy. While highlighting the risks of the Ukraine-Russia war on growth and inflation, market participants seem to be emboldened by Powell’s belief in a continued expansion of the US economy.

5. Quantitative tightening could come soon

The Fed’s policy statement outlined that it ‘expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting.’ During Chair Powell’s press conference, the Chairperson highlighted that this could begin as soon as May when the FOMC next meets.

Ostensibly, the markets welcomed the Fed’s decision. Helped along by the news out of Eastern Europe and China, Wall Street rallied into the close, led by the NASDAQ, with the US Dollar dropping and riskier currencies rallying. The AUD/USD charged higher by around 1%, to push back towards the 73-handle. However, it wasn’t all positive signals as the bond market continues to flash signals of an economy that’s slowing down at a significant rate.

Yields were higher across the curve as market participants betting on a Fed that will move in synchrony with market expectations for rates and the reduction in the size of the balance sheet. The yield curve bear flattened too, with a big jump in yields at the short-end compressing the 10-2 spread to around 25 basis, as the curve continues to trend in a way that might eventually portend recession in the United States – or, it might be appropriately stated, a bust to end this booming economic cycle.

Follow Kyle Rodda on Twitter @KyleR_IG

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