Fed speech, interest rate forecast update; May Fed meeting preview
Overview of central bank supervision:
- Rates markets are fully pricing in a 50 basis point rate hike by the Federal Reserve on Wednesday.
- The rates markets completely ignored any “dovish” impact from the Russian invasion of Ukraine.
- We’ll be discussing how markets may react to the Federal Reserve’s May rate decision beginning at 1:45 p.m. EDT / 5:45 p.m. GMT on Wednesday, May 4, 2022. You can join live by watching the stream at the top of this note.
A more Hawkish FOMC is coming?
In this edition of Central Bank Watch, we will review comments and speeches made by various Federal Reserve policymakers throughout April. Although there have been no Fed speakers since the communications blackout began on April 23, nothing has materially improved in recent weeks on the inflation front that would suggest that a less hawkish FOMC will arrive this Wednesday.
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50-bps or 75-bps in May?
There has been a noticeable change in tone among Fed policymakers since the beginning of April. While most officials thought a 25 basis point rate hike would be appropriate in May, recent inflation data has spurred a more hawkish rhetoric shift, with several FOMC members openly advocating a 50 basis points – and one even mentioned the possibility of a 75 basis point rate hike.
April 1 – Evans (Chicago Chairman) said his outlook matched the median estimate of fellow policymakers, calling for six more 25 basis point rate hikes in 2022.
April 2 – Williams (President of New York) indicated that rate hikes would come gradually over the year, but that markets should brace for continued tightening in 2022, noting “cObviously, we need to get something more normal or neutral, whatever that means.
April 3 – Daly (San Francisco President), who is generally on the dovish side of the spectrum, said that “tthe case of 50, except negative surprise by the next meeting, grew,” and that “taking these first adjustments would be appropriate.
April 5 – Brainard (Fed Governor) called the Fed’s task of reducing inflation “paramount,” while noting that balance sheet reduction would begin soon. “Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to contract considerably faster than in the previous recovery, with significantly higher ceilings and a period much shorter to phase in the maximum caps compared to 2017-2019.”
April 6 – Harker (Philadelphia President) said inflation is “far too high” and expects “a series of deliberate and methodical hikesthe year goes on and the data evolves.
April 7 – Bullard (Chairman of St. Louis) continued to assert his position as the most hawkish member of the FOMC, noting that he preferred a 50 basis point rate hike in May and that he “would like the committee to arrive at 3-3.25% on the policyrate in the second half of this year.
April 10 – Mester (president of Cleveland) warned that “it will take time to bring inflation downbut remained confident that the United States would avoid a recession in 2022.
April 11 – Waller (Fed Governor) said the Fed was trying to raise rates”in a way that there are not many [collateral damage to the US economy]but we cannot adapt the policy.
Evans took a more hawkish turn from earlier this month, saying that “IIf you want to go neutral by December, that would probably require something like nine hikes this year, and you won’t get that if you only do 25 at each meeting», while noting « so, I can certainly see the case.
April 12 – Brainard said the Fed would move “rapidly” to raise rates, and will fight inflation via “a series of interest ratesincreases as well as the beginning of this balance sheet runoff.
Barkin (president of Richmond) suggested that “youThe best short-term path for us is to move quickly into the neutral range and then test whether pandemic-era inflationary pressures are easing and how persistent inflation has become.
April 13 – Bullard warned that if the Fed doesn’t tighten policy quickly enough, it will hurt its own long-term credibility.
Waller said he would prefer to see a more aggressive tightening sooner, noting that he “prefer a front-loading approach. So an increase of 50 basis pointsin May would be consistent with that and maybe more in Juneand July.
April 14 – Williams said 50 basis point rate hikes are a “reasonable option” given the dovish policy.
Mester suggested the Fed will be cautious when raising rates, saying “Our intention is to reduce accommodation at the pace necessary to better balance demand with limited supply to keep inflation in check while supporting expanding economic activity and healthy labor markets.”
April 18 – Bullard said a rate hike above 50 basis points is not his “baseline scenario”, but he “wouldn’t rule it out”.
April 19 – Evans noted that the Fed is “pmost likely…go beyond neutral,” neutral being the level of interest rates that neither supports nor hinders the economy. In doing so, he sees3 to 3.5% inflation” by the end2022.
Kashkari warned that the Fed is “going to have to do more thanks to our monetary policypolicy tools to roll back inflation” if supply chains remainconstrained.
April 20 – Daly commented that “mdeliberately adopting a more neutral stance that does not stimulate the economy is the top priority», and sees the neutral rate around 2.5%.
The Fed’s Beige Book was released, with inflation still the focus. “Inflationary pressureshas remained strong since the lastreport as companies continue to pass on rapidly rising input costs youto customers.
April 21th – Daly suggested that aggressive tightening was imminent, with the Fed “take a raise of 50 basis pointsin a few meetings, also starting our reviewdiscount program.
Powell said he was in favor of “front-loaded” rate hikes, agreeing that “50 basis points will be on thetable forthe May meeting.
Several rate hikes
With US inflation rates at a new multi-decade high, markets have delayed expectations of a rapid pace of rate hikes over the next few months. We can measure whether a Fed rate hike is priced in using Eurodollar contracts by looking at the difference in borrowing costs for commercial banks over a specific time horizon in the future. Chart 1 below shows the difference in borrowing costs – the spread – for the May 2022 and December 2023 contracts, to gauge the direction interest rates will take by December 2023.
Eurodollar futures spread (May 2022-December 2023) [BLUE]USA 2s5s10s Butterfly [ORANGE]DXY Index [RED]: Daily period (May 2021 to May 2022) (chart 1)
By comparing the odds of a Fed rate hike with the US Treasury butterfly 2s5s10s, we can assess whether or not the bond market is acting in a manner consistent with what happened in 2013/2014 when the Fed signaled its intention to reduce its QE program. The 2s5s10s butterfly measures non-parallel shifts in the US yield curve, and if the story is accurate, that means mid-rates should rise faster than short or long rates.
After the Fed raised rates by 50 basis points in May, six 25 basis point rate hikes are expected through the end of 2023 thereafter. The 2s5s10s butterfly has been trading sideways in recent weeks, suggesting that the market has retained its global hawkish interpretation of the near-term trajectory of Fed rate hikes. The focus remains more on the Fed and less on Russia’s invasion of Ukraine.
Federal Reserve Interest Rate Expectations: Fed Funds Futures (May 3, 2022) (Table 1)
Fed funds futures have remained very aggressive in recent weeks, with a rapid pace of tightening expected over the next three meetings. Traders see a 100% chance of a 50 basis point rate hike in May, June and July, with the Fed’s key rate expected to reach 2.75% (currently 0.50%) by the end of the month. 2022.
IG Customer Confidence Index: USD/JPY Rate Forecast (May 3, 2022) (Chart 2)
USD/JPY: Retail trader data shows 30.69% of traders are net long with a ratio of short to long traders of 2.26 to 1. The number of net long traders is 5.16% lower than yesterday’s and 25.90% higher than last week, while the number of net-short traders is 3.47% higher than yesterday and 6.10% lower than last week .
We generally take a contrarian view of crowd sentiment, and the fact that traders are net short suggests that USD/JPY prices may continue to rise. Positioning is more net-short than yesterday but less net-short since last week.
The combination of current sentiment and recent changes gives us another mixed USD/JPY trading bias.
We’ll be discussing how markets may react to the Federal Reserve’s May rate decision beginning at 1:45 p.m. EDT / 5:45 p.m. GMT on Wednesday, May 4, 2022. You can join live by watching the stream at the top of this note.
— Written by Christopher Vecchio, CFA, Senior Strategist