Post Federal Open Market Committee Commentary
June 21, 2022
The following insights are provided by Smith Shellnut Wilson, LLC. (SSW), a b1BANK affiliate.
Federal Reserve officials raised their main interest rate by 75 basis points. It was the largest overnight rate increase since 1994. They also signaled that they would keep hiking aggressively this year, resorting to drastic measures to restrain the rampant inflation they failed to grasp last year. The rate shifted from a range of 0.75% - 1.00% to 1.50% – 1.75%. The Fed forecast that the overnight rate will increase to 3.40% by year-end, or 175 basis points more in 2022 tightening. At the March meeting, the median forecast was for 1.90% by year-end. The median peak in the overnight rate is now forecast to touch 3.80% during 2023.
The Fed did indicate that they would shrink the $9 trillion balance sheet by $47.5 billion a month (started June 1) and that they would step that up to $95 billion a month by September. Many economists have pointed to the massive balance sheet and increase in money supply following the pandemic as a major reason for the current price pressure. They point out that this is not an over-heated economy, but rather too many dollars chasing too few goods/services. They claim the FOMC should be more focused on extracting liquidity from the markets (selling bonds faster) as opposed to hiking short-term interest rates.
The Fed targets a 2% PCE price index target while the current market is running at about three times that level at a near 40-year high of 6.3%, through April. They forecast that would average 5.2% for the year, up from 4.3% in March projections.
The Fed also forecast GDP growth to slow to 1.7% for 2022, down from 2.8% at the March meeting. They projected the unemployment rate to rise to 4.1% by 2024, up from 3.6% currently.
Immediately following the release, the bond and stock markets digested the rate move and comments rather well. Treasury yields fell (bonds gained) across the curve, credit spreads narrowed, and stock prices pushed robustly higher. The effective Fed Funds rate rose from 0.80% to 1.60% and the Prime rate is expected to adjust up from 4.00% to 4.75% tomorrow.
Bottom line: This 75-basis point move became widely expected over the last 2 business days after most economist had predicted a 50-basis point FOMC hike over the last few months. The markets’ positive reaction was surprisingly telling – indicating it was almost relieved by the highest hike in almost 30 years and that the Fed is now taking price inflation seriously. The positive market reaction could continue to be seen during Powell’s post announcement Q&A when he continued to highlight the efforts the Fed would take to control inflation. The next focus area will be the Fed’s balance sheet and the aggressiveness of bond selling. The portfolio is $9 trillion, and even at $95 billion a month, it will be a slow process of pulling dollars back out of the U.S. economy.
Remaining FOMC Rate Decisions: July 27 (probability of +75bps), Sept 21 (probability of +50bps), Nov 2 (probability of +50bps), Dec 14 (probability of +25bps).
SSW provides a Financial Weekly Newsletter, quarterly Economic Commentary, and FOMC meeting update recaps on their website. To read more of their thoughts, click here.