The January FOMC minutes will be scrutinized for details of the Fed’s tightening path. The concept of risk aversion remains active in relation to macro-environment and policy tightening at a time of heightened geopolitical tensions. A hawkish tone adopted by Powell at his press conference, combined with recent comments from Fed members, prompted speculation of a 50 basis point gain in March that would be steeper than previously anticipated.
Whether the FOMC committee has the appetite for a 50bps increase in March—as markets are now pricing in—will depend on members’ and Fed staff’s assessment of the urgency of the inflation outlook and whether the Fed is “lagging behind”. As the January data suggest, the US continues to experience strong price increases, but the global economy may see inflation pressures continue as growth slows, highlighting the possibility of central bankers entering a slowdown. Slowing growth dynamics jeopardize the implementation of a much more challenging and aggressive tightening path for Central banks. Inflation projections may be raised in March. In December, the central trend for core PCE was formed in the band of 2.5-3% for 2022. In fact, the assumption that the inflation outlook is temporary for this year and next year is important for the formation of expectations here. Expectations that may get aggressive in March will mean faster balance sheet tightening.
There are some reservations about employment that are still causing problems and that for a period the increase in the workforce is also limited. While discussing the economic situation, there is also the effect of labor market supply shortage caused by the Omicron wave. However, the trend is positive and the drop in the unemployment rate offers important signs that the market is very tight. At the point of reaching maximum employment, the FOMC may go for a more convinced image. The central trend of unemployment rate estimates in the December FOMC is also in the range of 3.4-3.7%. This indicates that the views of the members dominate the point of achieving the Fed’s goals. So reservations are limited.
Fed futures funds rate pricing… Source: Bloomberg, CME Fedwatch
Market prices are already known. An increase of 50 basis points is not a step anyone would prefer. We saw sales that became the main expectation, up 50 basis points across all asset classes. From March to July, the expectation of 3 or 4 interest rate hikes is weighted. But sales, of course, are not only due to this phenomenon. There is a clear flattening in the US yield curve, with 2-year and 10-year spreads narrowing. Ahead of the March meeting, we will look for clues to the Fed’s actions in data such as nonfarm payrolls or the PCE. The scenario that the market will like may be data that does not contribute to the expected rate hikes by the Fed or that the bond market has gone too far. In other words, if we get signals that inflationary pressures are softening or slightly softening, the expected 50 basis point rate hike from the Fed may be withdrawn or its marginal effect may decrease.
In a very short time, the market came to expect 7 rate hikes from the Fed’s 3 rate hike expectations. An aggressive balance sheet cut is still not priced in, and harsh US data could cause this phenomenon to be included in prices. We will pay attention to the details of the comprehensive discussion of balance sheet normalization in the minutes. An attempt will be made to understand the extent of normalization about the tendency to potentially sell from the bond portfolio and to sell the pot-backed securities. It would not be a surprise if the Fed started its balance sheet reduction with bond sales from the middle of the year.
The Fed is trying to understand whether inflation is at risk from the demand, salary and credit phenomenon at the policy control point, or whether it is experiencing real risk due to the supply chain. We will aim to capture the details of the balance sheet cut and 50 basis point rate hike views in the Fed minutes. The January FOMC minutes may provide clues to this and explain why Powell made such a hawkish push after the meeting.
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