“The Fed will face one of the toughest tests in history,” said Jim Karen Morgan Stanley, head of Global Macro Strategy Division, Investment Management.
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In fact, economists predict that the US economy will grow more than 9% year-on-year in the second quarter (April-June), and accordingly, the number of new non-farm workers will increase by an average of more than 1 million over the next several months. In the employment trend for the third quarter, which was already announced last weekend, the number of employed people reached 916,000, 250,000 more than expected, and this atmosphere is already being detected.
After the release of such employment indicators, the US Federal Fund Rate (FFR) futures market has a higher outlook for a base rate hike from December next year to spring 2023.
Peter Bukvar, the chief investment strategist of the Bleekley Advisory Group, said, “The situation has changed completely due to the employment indicators in March. It started to be a year ahead.” In the last FOMC, policymakers predicted the first rate hike in 2024 through a dot plot.
Last year, the Fed introduced the average price target system (AIT) and changed its policy to tolerate inflation even if it temporarily exceeded the 2% inflation target. This is because even if inflation exceeds 2% at one time, it was judged that in order to escape the shock caused by the Corona 19 pandemic (a global pandemic), it was necessary to maintain a zero interest rate policy and an asset purchase program for a longer period.
First of all, inflation may seem relatively high this spring due to the base effect of the shutdown (economic blockade) at the beginning of last year when the Corona 19 pandemic began. Accordingly, Fed Chairman Jerome Powell said, “Inflation may be temporarily raised,” and he does not take inflation very seriously.
However, some of the market believes that demand growth may appear steeply as demand delayed due to the pandemic is added, and inflation may appear steeper if government fiscal stimulus measures are added.
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“Now the Fed will face challenges, and April to May, when the economic indicators are likely to be good, will be the most difficult period,” said Karen. Based on personal consumption expenditure (PCE) inflation, which is used as a measure of monetary policy, it can go up to 2.5%. At this time, the Fed predicts that inflation is temporary, and only convinced of it will maintain market confidence.”
The better the economic indicators, the harder the Fed will persuade the market. The March Consumer Price Index (CPI) will be released next week, which could increase considerably given the price decline in March last year. February’s CPI rose 1.7%, the highest in a year.
“The Fed wants a full recovery and will wait until the end,” said Diane Swongk, chief economist Grant Thornton. He believes that the CPI may temporarily exceed 3% depending on the situation.
He said, “The Fed will not reflect the effects of infrastructure investment in its economic outlook until the tangible figures are confirmed, but the bond market will preemptively take this into account,” he said, and feared that market interest rates could jump earlier than the Fed’s expectations. Currently, the 10-year Treasury bond yield is maintained at 1.71% in the US Treasury market. This is a 90bp (0.9% point) increase in the first quarter of this year alone.
Even recently, the two-year Treasury bond rate, which is sensitive to the base rate, is also jumping. In particular, after the release of the employment index in March, the 2-year interest rate rose to 0.18%, the highest in the last 14 months.
“If the economic indicators continue to improve, the market could continue to press the Fed (to raise the benchmark interest rate), but the Fed will still freeze interest rates until 2024,” said Karen. Fed officials are the most important as they are moving.
Michael Schumacher, director of interest rates at Wells Fargo, said, “The current market is reflecting a total of three rate hikes until 2023 in the price.” “The market will continue to reflect more rate hikes. How will Fed Chair Jerome Powell respond? It’s the key,” he said. “You will see (inflation) numbers that no one has seen before, but as the Fed’s method of targeting inflation has changed, the response is inevitable,” he said. “After all, the key is how the Fed responds when inflation exceeds 2%. It will be.”
Nevertheless, it is clear that the Fed’s rate hike will be very slow. First of all, it will start reducing the amount of purchases of government bonds and mortgage-backed securities (MBS), which are currently worth $120 billion per month.
Mark Cabana, president of Bank of America (BoA) US interest rate strategy, said, “The Fed will soon begin to reveal its intentions to reduce its asset purchase program.” I will review it.” Accordingly, CEO Cabana expected to change the ambiguous expression of’substantial further progress (of economic indicators)’, which the Fed proposes as guidance for adjustment of the standard interest rate, in a more specific way.
However, the better the economic indicators come out, the more rebellious votes will increase within the Fed.
In fact, Robert Caplan, the governor of the Dallas Federal Reserve Bank, who is considered a hawkish policy committee member in the FOMC recently, said, “We need to raise the base rate earlier than the FOMC consensus.”
Mr. Cabana said, “With the improvement of economic indicators, regional governors will also become more nervous, which will create a dissonance within the FOMC.” Strategist Bukvar also said, “As the market is ahead of the Fed, at some point it will eventually lead the Fed toward tightening the currency. Expects to go to policy coordination.”