Fed Delivers a 75bps Rate Hike

    • The Fed relented to market pressure and raised the overnight fed funds target rate 75bps to 1.50% – 1.75%. The stronger-than-expected May CPI Report has kept financial markets under pressure since its release last Friday and the Fed acknowledged that pressure with the need to move in larger increments in its rate-hiking campaign. The vote was 10-1 in favor with KC Fed President Esther George dissented wanting only a 50bps hike.


    • The updated Dot Plot now shows the fed funds rate reaching 3.40% by the end of 2022, moving to 3.80% in 2023, and back to 3.40 in 2024. The 3.80% level still falls short of futures market pricing which sees the funds rate touching 4.25% in early 2023 before starting to move lower in late 2023. The longer-run fed funds neutral rate is forecast to now be 2.5% vs. the 2.4% estimate from March. That seems a little light given the persistence of inflation to this point.


    • The market was priced for the funds rate to nearly reach 3.75% by year-end, so the Fed didn’t match that level but they did come quite a way from the 1.875% year-end projection they had in March. For some time now, the market has been pulling the Fed in its direction on rate hikes and this continues to be the case.


    • While the Fed is frustrated with the persistent inflation pressure to date, they continue to project inflation will move quickly lower. For Core PCE, they see it ending 2022 at 4.3% from its current 4.9%, and down to 2.7% in 2023, and then to 2.3% in 2024. So, the Fed continues to see a quick reversion to pre-pandemic levels. We shall see.


    • The Fed now forecasts that the rate-hiking campaign will have a somewhat muted impact on the labor market with the unemployment rate projected to finish the year at 3.7% vs. the current 3.6%. The rate is projected to climb to 3.9% in 2023 and 4.1% in 2024. Those levels also seem a little light given the expected rate hikes to come.


    • Also, despite the more aggressive rate-hiking projections, and the projected increase in the unemployment rate, the Fed doesn’t call for a recession. For this year, they see GDP growth at 1.7%, significantly down from the 2.8% they saw in March. However, with a negative 1.5% in the first quarter, that projection implies decent growth in the next three quarters despite higher rates and extreme market volatility. That seems questionable. For 2023, they have GDP also at 1.7% and 1.9% in 2024. That’s a bit weaker than the March projections but still projecting a soft landing.


    • Overall, the Fed bowed to market expectations and delivered a 75bps hike and looks to deliver more in the coming meetings to reach their projection of 3.75% by year-end. However, despite the more aggressive rate hiking projections the Fed sees only a minimal increase in unemployment and an economy that avoids recession with a soft landing. That seems to be a bit of wishful thinking given the magnitude of expected rate hikes.


Source: Bloomberg


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 3.36 3.55 3.64 3.79 3.95 4.41
0.50 3.34 3.52 3.58 3.68 3.80 4.30
1.00 3.34 3.49 3.55 3.63 3.72 4.17
2.00 3.48 3.49 3.55 3.60 NA
3.00 3.51 3.54 NA
4.00 3.49 NA
5.00 3.45 NA
10.00 NA

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Published: 06/15/22 Author: Thomas R. Fitzgerald