Fed: Tightening in FOMC, balance sheet communication


The first Fed meeting of the year started as of today. Recent indications have indicated that the Fed will begin rate hikes as early as the March meeting. Therefore, in this meeting, we will follow the Fed’s signals for a near-term rate hike, as well as its planning and communication in terms of how it is done. US treasury yields and the dollar alike rose on anticipation of a quick tightening ahead of the Fed meeting, with a front loading in the making of expectations. Now, there is a mixed market outlook that takes into account the upside risks, fears a possible policy error and tries to calculate the risk of dam descent. All, for example, how fast the Fed will raise real interest rates or how willing it will be, will also be the planning of the QT progression sequence.

To elaborate; While the biggest price pressures of recent years caused high inflation in developed countries, the USA was ahead of many economies in both economic recovery and inflation. Omicron, the economy sentiment has gone back a bit lately due to politics and political concerns. Cost pressures, on the other hand, remain steep, and it is seen that the main cause of inflation is not demand but external factors originating from supply and cost. The externality factor is a usual challenge in policy making, so you cannot check whether the policy measures taken will clearly work. The Covid pandemic also reversed such a policy transformation sequence and had to switch to ultra-loose liquidity mode with a shock rate cut. The two-year expansionary policy has come to an end and the reflationary policy is now being replaced by a tightening policy.

On the other hand; The risks of virus-induced restrictions in the economy remain in parentheses. However, it may be necessary to evaluate the event in the axis of newly sized supply problems and political risks. Any significant impact could lead to lower revisions of GDP forecasts and be a cause for concern for policymakers, who have been increasingly hawking in recent weeks. However, a key secondary Omicron effect to watch for will run through inflation. Global supply delays showed signs of easing in December, but any renewed extension will likely lead to higher prices, especially when coupled with renewed restrictions on manufacturing output. We can also think of this in terms of oil prices, which can be accelerated by disruptions caused by geopolitical developments. Rising commodity prices will mean additional inflationary effects.

It seems that; The Fed needs to strike the right balance between taking inflation seriously and not wanting to cause more unnecessary turmoil in the markets. It’s not an easy balancing act when four rate hikes are priced alongside the balance sheet reduction and some argue that’s not enough. That’s actually a lot of pressure for a “non-live” meeting under normal circumstances, but investors will hang on to just about every word spoken. Therefore, the Central bank needs to strike the right chord while tightening it so that the string does not break and the sound is correct. This is a situation that needs to be calculated not only in terms of calming the market, but also in terms of the impact on the economic transformation.

At this stage, if we reorder and evaluate the possibilities available;

Do we end our bond purchases immediately at this stage? It is not possible because there is no communication. The Fed will completely end its bond purchases in March at the planned pace.

Will the rate hike start in March? Absolutely. Communication and pricing already done. The rate matters.

A 50 basis point rate hike? It is not the base scenario, but I cannot say that it is impossible in terms of proactiveness in taking the initiative in inflation. It was last done in 2000.

When does the balance sheet start to shrink? Not now, but the Fed won’t wait for the paint to dry either. The June – August period seems appropriate. The aftermath is important, this will happen not only when redeemed bonds are off balance sheet, but also with QT. It will have an impact on long-term interest rates and mortgage rates.

Kaynak: Tera Yatırım
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