▷ How serious is the Fed?, market commentary by Kai Johannsen


28.01.2022 – 20:00

Stock exchanges newspaper

Frankfurt (ots)

Is the Fed serious? And above all: if the US monetary authorities are serious – will they be able to stick to the announced monetary policy course in the coming months or one to two years, not least because of the market effects that will occur? These are the questions players in the financial markets are grappling with after the most recent meeting of the Fed’s FOMC last Wednesday.

In view of the high rate of inflation, the Fed is now quickly striving for a tighter course in monetary policy, ie it wants to move the key interest rate away from the historic lows. In addition, she wants to slim down the central bank’s balance sheet, which has been inflated by enormous bond purchases. After the monetary policy meeting, the Fed said that an interest rate hike would soon be in order. According to Fed Chair Jerome Powell, US monetary authorities stand ready to tighten in March if conditions warrant it. Further upward interest rate adjustments are likely to follow in the course of the year. There’s plenty of room for tightening, Powell said, without jeopardizing the recovery in the labor market. At the most recent meeting, the US central bankers left the key rate unchanged in the range of 0 to 0.25 percent. The Fed also wants to put an end to bond purchases in March.

Even 50 basis points?

Many market participants are expecting a key rate hike of a quarter of a percentage point in March. That is the market consensus. In some cases, however, a stronger tightening is expected in retail should inflation in the USA rise more sharply. The US Federal Reserve is currently facing the strongest inflation since the early 1980s. With an increase in the price level of 7 percent, inflation is well above the Fed’s self-imposed target of 2 percent. The Covid-19 crisis is causing a bottleneck for many materials and preliminary products, and energy prices are also driving inflation considerably. Some economists therefore do not rule out that the Fed will even hike by 50 basis points. The last time there was such a strong tightening was in May 2000.

There are certainly voices in the market that are at least suggesting that the Fed will not just go ahead with tightening. The Fed press conference accelerated the flattening of the US Treasury curve. Powell hinted that a more aggressive approach might be needed, and reiterated that interest rates remain the “primary vehicle” for adjusting monetary policy, Commerzbank’s interest rate strategists note. With this press conference, the risk has increased that the Fed will hike rates more than four times this year, which is now fully priced in by November. But the Fed should be careful not to fuel the stock sell-off and curve flattening any further, as the curve is already much flatter than when past rate hikes began. Accelerating balance sheet reduction remains a risk, and Powell acknowledged “This is a ‘relatively new’ tool with which the Fed has limited experience. However, given the huge increase in debt and the vulnerability of equities to rising real yields, the rise in yields should be slowed down,” according to Commerzbank experts. Finally, the Fed must ensure that there is no abrupt deterioration in general financial conditions. they are right. This will probably quickly tie the hands of the Fed.

And the pundits at bond giant Pimco are also cautious, saying the end of the road could be reached sooner than in previous interest rate cycles. It is now assumed that the key interest rate will be raised in March and that a series of four interest rate hikes will be initiated in 2022. But then they continue: “Although the Fed’s short-term interest rate path points to an earlier and more rapid hike in response to inflationary risks, we continue to expect a still-low neutral interest rate, a larger central bank balance sheet, and generally higher aggregate debt levels to mark the final levels of this cycle of interest rate hikes at or even below the level reached in 2018 – i.e. in a range of 2.25 to 2.5 percent,” says Tiffany Wilding, US economist at Pimco. As a result, there might be a bit of optimism in the tightening market right now.

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