Below is a brief recap of the views of Tim Ng and Tom Hollenberg, fixed income portfolio managers and members of Capital’s interest rates team, regarding the Fed’s announcement on 16th June.

Fed officials projected two interest rate increases by the end of 2023, signalling a faster-than-anticipated pace of policy tightening as the economy recovers.

This is a meaningful shift for the central bank. Chairman Jerome Powell’s remarks following the two-day Federal Open Market Committee (FOMC) meeting suggest Fed officials may have become concerned by recent inflation reports. Powell said the Committee still views the recent bumps in inflation as mostly driven by temporary factors that will likely go away over time. But he also acknowledged that there is tremendous uncertainty as to when these factors may dissipate.

Inflation pressures have been greater than expected over the last two months. The Bureau of Labor Statistics reported a 0.8% jump in the month-over-month headline consumer price index (CPI) in April and a 0.6% rise in May ― among the two biggest monthly increases since 2009.

Powell also appeared concerned that higher realised inflation could feed into expectations. He said that the Committee now acknowledges that longer-term inflation expectations have moved to a range consistent with the Fed’s long-run inflation goal of 2% rate as measured by the personal consumption expenditures price index (PCE).

The central bank held the target range for its benchmark policy rate unchanged at zero to 0.25% ― where it’s been since March 2020 ― and pledged to continue asset purchases at a $120 billion monthly pace until “substantial further progress” has been made on employment and inflation. The FOMC vote was unanimous.

The Fed’s projections showed 13 of 18 officials favoured at least one rate increase by the end of 2023, versus seven in March. Eleven officials saw at least two hikes by the end of that year. In addition, seven of them saw a move as early as 2022, up from four.

While Powell tried to soften talk of rate hikes and the dot plot, his focus on upside risks pulls forward the most likely timeline for tightening. Overall, the Fed seems optimistic about the economy and appears ready to begin formal discussion on reducing its asset purchases. In the earliest scenario, a formal announcement on tapering could be made at the next Fed meeting on 27-28th July, although later this year appears more likely. The asset reduction programme would most likely last from eight to 12 months, roughly in line with the pace of reductions in 2013.

Powell was also surprisingly very upbeat about the labour market recovery even though unemployment has declined at a slower pace than anticipated. The May report showed the US unemployment rate at 5.8%, still significantly higher than before the pandemic. And so, if inflation remains elevated, we think the Fed will likely raise interest rates in 2023. A rate increase as early as December 2022 is not off the table.

 

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