While the Federal Reserve (Fed) didn’t change monetary policy today, it signaled the broad strokes of normalization. It all but confirmed that the first rate increase will occur in March and that policymakers will explore reducing its balance sheet in the months afterward. This is the appropriate path forward in our view.
Today’s market reaction was somewhat mixed. Stocks gave back most of the day’s gains but were due for a breather following a strong move from Monday’s lows. Key bond yields rose, especially on the short end. .
At its January rate-setting meeting, the Fed left overall monetary policy unchanged. It also maintained the pace of its monthly bond purchases of $20 billion of U.S. Treasuries and $10 billion of mortgage-backed securities, which will conclude in early March. However, Fed board members stated that the first rate hike will soon be appropriate in response to stronger near-term inflationary pressures as a result of supply-chain bottlenecks and the ongoing reopening of the U.S. economy.
During the post-meeting press conference, Fed Chair Jay Powell underscored the substantial progress that has been achieved, particularly within labor markets, highlighted by the unemployment rate at 3.9%. He stressed that the Fed’s approach will be flexible and nimble.
Chair Powell also made the point of saying that the Fed’s "communications are working," which we interpret as meaning “the Fed is very comfortable with current market expectations for normalizing monetary policy.”
Chair Powell did well during the press conference, fending off pointed questions on the specifics yet clearly signaling the rate liftoff would occur in March and that four rate hikes in 2022 were a possibility. He also dissuaded the notion of hiking raising rates in larger half point increments rather than quarter point moves. While our 2022 base case view of three rate hikes is below the four or five hikes currently projected by futures markets, we see upside risk to our view. Quite simply, it means four hikes is a possibility if inflation and growth conditions permit, but it’s not our base case.