Fed: Countdown to March lift-off! | Article - ING Think

The Federal Reserve admits rate hikes are coming. ... Consequently, we are expecting a 25bp rate rise at the March FOMC meeting and in the ... THINKEconomicandFinancialAnalysis Togglenavigation Menu Home Markets FX Credit Rates Commodities 24June2022 Watch:What’snextforEUR/USD? 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Authors JamesKnightley PadhraicGarvey,CFA ChrisTurner TheFederalReserveadmitsratehikesarecoming"soon"andthiswillbetheprimarytooltotightenmonetarypolicy.Theyarealsolayingthegroundworkforshrinkingtheirbloatedbalancesheet,yetareactuallyaddingtoituntilMarch!Policychangeswillcontinuetobewellflaggedwithfourratehikesourexpectedminimumthisyear Inthisarticle InchingtowardsactiondespiteongoingQE Minimumoffourratehikes,butitcouldbemore Thebalancesheetwillcontributetoo Marketrateschoosetoedgehigher,onacalminginfluenceforriskassets FX:Allveryorderly Shutterstock Share DownloadarticleasPDF Newsletter StayuptodatewithallofING’slatesteconomicandfinancialanalysis. SubscribetoTHINK InchingtowardsactiondespiteongoingQE TheFederalReservehasleftpolicyunchanged,butsignaled“itwillsoonbeappropriatetoraisethetargetrangeforthefederalfundsrate”.TheyarealsocontinuingtobuyassetsaspartoftheirQEplanuntilearlyMarch,whichseemsastrangedecisiontous.FedChairJeromePowellhadsaidearlierthismonththat“we’remindfulthebalancesheetis$9trillion.It’sfarabovewhereitneedstobe”.Whyoneartharetheyaddingtoit?Thisseemsevenmorepeculiargiventheyhavereleasedadocumenttitled“principlesforReducingtheSizeoftheFederalReserve’sBalanceSheet”.Wecanonlyconcludethattherecentvolatilityinfinancialmarketshasledthemtotreadcautiouslyandnotsurprise. IntermsofthepressreleasetheFedtalksofstrengtheningactivityand“solid”jobgainswhileacknowledgingthat“supplyanddemandimbalancesrelatedtothepandemicandthereopeningoftheeconomyhavecontinuedtocontributetoelevatedlevelsofinflation”.Consequently,weareexpectinga25bprateriseattheMarchFOMCmeetingandinthepressconferencePowelladmitsFOMCmembersare"ofamind"todoso. Minimumoffourratehikes,butitcouldbemore Thedatabetweenthenandnowisn’tgoingtobeprettythoughwithaclearriskthatDecember’sawfulconsumerspendingnumbersarerepeatedinJanuarygivenalltheCovidcautionaround.TheJanuaryjobsnumbercouldalsobeverysubduedforsimilarreasonsandthisislikelytodampentheverynichecallsfora50bpratehikeinMarch. Nonetheless,wearehopefulofasecondquarterreboundgivensolidincomefundamentalsandthiswillsetusupforatleastfourratehikesin2022.Indeed,inthepressconferenceFedChairJeromePowelldidnotruleoutraisingratesateveryFOMCmeeting,arguingthattheFedhasplentyofroomtoraiseinterestrateswithouthurtingthejobsmarket. Thebalancesheetwillcontributetoo InthesecondFeddocumentregardingthebalancesheettheyconfirmthattheprimarymonetarypolicytoolischangingthe Fedfundstargetrateandthat"reducingthesizeoftheFederalReserve'sbalancesheetwillcommenceaftertheprocessofincreasingthetargetrangeforthefederalfundsratehasbegun".Balancesheetreductionwillbedone"inapredictablemannerprimarilybyadjustingtheamountsreinvestedofprincipalpayments".Italsowantsitsbalancesheet"inthelongerrun"tobe"primarily"composedofTreasurysecurities. Itisfairlyvaguestuffandthereisnothingintherethatissurprising.Itwillbeasimilarpatterntopasttimes.TheFedhikesacoupleoftimes(MarchandJune)andthenpresumablyinJuly/Auguststartsallowingacappedamountofmaturingassetstorunoffitsbalancesheet.Itwillstartslowly,probablyataround$10bnforTreasuriesand$8bnforMBSandthenbeaccelerated,assumingeconomicconditionsallow,uptoaround$50bnand$40bnrespectivelypermonth.GiventheFedstatesitprimarilywantstoholdTreasurySecurities"inthelongerrun”, agencyMBSmaybeallowedtorunoffataslightlyquickerratethanTreasuries. AssetsontheFederalReserve'sbalancesheetandthepotentialpathto"normalisation" Macrobond,ING Theydon’tgiveusafigureforthesizeofbalancesheetthattheythinkmightbewarrantedinthemediumtolongerterm,merelystatingtheFed“intendstomaintainsecuritiesholdingsinamountsneededtoimplementmonetarypolicyefficientlyandeffectively”.Currentlyweareat$8.75tn,equivalenttoaround36%ofnominalUSGDP.BoardofGovernormemberChrisWallerhassuggestedhethinksthebalancesheetshouldoverthelongrunbearound20%ofGDP.Assumingtheyaimfora5-yearrundownthiswouldimply$2.8tnofassetsleavingtheirbalancesheet.Thelonger thetimeframe,thelessreductionrequired,obviously. Marketrateschoosetoedgehigher,onacalminginfluenceforriskassets AsmalluptickinratesalongthecurvehasbeentheimpactreactionfromtheFed’sstatement.Thishasbeendrivenbyanudgehigherinrealrates;inflationexpectationsremainsteady. ThelackofnewnewsfromtheFed’sstatementallowsthemarkettolatchbackontothepathofleastresistance,whichrightnowisupinmarketrates,abit.RiskassetshavenotseenanynewshockfromtheFed,whichissupportive.ThereisarguablyawindowoftranquilitynowforriskassetsaswerollforwardtotheMarchmeeting,whichisquitesomedistanceaway. InthemeantimetheFedhascutnothingandcontinuestobuilditsbalancesheet(notaperingyet).Nopanictighteninghere.Nooverreaction,despitethemarkettalk.Reliefforriskassetsleavesroomformarketratestore-testhigher.Butoverall,wearebacktomonitoringthepulseoftheeconomy. NotwithstandingtheheadwindsthatcomefromOmicrom,andcancomefromUkraine-relatedissues,thebondmarketismindedtolookupinyieldratherthandown.ThecountertothisisongoingFedandexternalbuyingofTreasuries.TheFed’sstatementhasdonelittletochangethatnarrative,atleastfortoday. FX:Allveryorderly TheinitialreactioninFXmarketstotoday’sFOMCstatementhasbeenrelativelymuted–sincethemarkethadalreadypricedthestartoftheFedtighteningcycleinMarch.Iftherehasbeenaslightmovement,ithascomefromthedollarmovinghigheragainstthelow-yielders,suchastheJPY,EURandCHF–currenciesmostsusceptibletohigherUSinterestrates. Marginallyoutperforminghavebeenthehighbetacurrencies.HereonecanarguethatsurprisesinneithertheFOMCstatementnortheFed’sbalancesheetdown-sizingguidesupportviewsofanorderlyratenormalisationcycle–reducingtherisksofshockstoriskassets. GiventhecurrenttensioninUkraine,whichshoulddemandageopoliticalandmacroriskpremiumofEuropeancurrencies,andtheloomingFedcycle,wewouldcontinuetobackNorthAmericancurrenciesin1H22.ThosecurrenciesintheorbitofthestrengtheningRenminbishouldalsobebetterabletowithstandFedandgeopoliticalrisksovercomingweeksandmonths.  Thisarticleispartof Lookingforwardtolookingback  View7articles Tags US QE Interestrates FederalReserve Balancesheet Share DownloadarticleasPDF Related 21January2022 WhattoexpectattheJanuaryFedmeeting 17September2021 FederalReservepreview:AnodtoNovember 16March2022 Fedhikes25bpwithmanymoretocome 22September2021 FederalReserve:DialNforNovember 18August2021 TheFed’stentativestepstotapering 9November2020 US:TheFed’sdoseofreality? 23February2021 US:Fedoptimismgrows,butthebuyingwillcontinue 3November2021 FederalReserve:thelongroadtonormalcy 16December2020 FederalReserve:Dovishtonewithmoreinthetoolkit 23July2021 Taperingtalkandpolicynormalisation:WhattoexpectfromtheFed 2March2022 Fed’sPowellconfirmsMarchlift-off 26July2020 US:FOMCpreview–calmbeforethestorm? 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