FOMC Meets to Accelerate Taper and What Else?

The FOMC meeting concludes this afternoon and we provide some early expectations of what we think we’ll see from the meeting in the sections below. With an updated economic and rate forecast, quarter-end meetings always have their fair share of intrigue, and with expectations of a faster tapering, this meeting has more intrigue than usual. The pace of tapering is expected to double, from $15 billion to $30 billion per month, finishing the task by mid-March. Then questions will swirl as to when rate hikes will begin, and at what cadence? That’s where the refreshed dot plots of future fed funds rate come in. For more insight into that, read on below to find our prognostication.

In our podcast this week we speak with Brady Gailey from KBW to discuss his outlook for bank M&A as we head into 2022 and perhaps a better environment than 2020, and 2021. The itunes link can be found here and the Spotify here.

New Dot Plots Bound to be Focus of the Meeting

One of the principal pieces of information we’ll get this afternoon from the FOMC meeting is the updated dot plot of forecasted fed fund rates. We expect that the 2022 forecast will have two rate hikes versus one in September, but the other interesting thing will be how many more in 2023? The September forecast had three hikes in 2023 with three more in 2024.

Source: Bloomberg

Now we should probably add the caveat here that the dot plots are merely each participant’s views on where they think the appropriate fed funds rate should be, given their own unique outlook on the economy and how that fits with Fed monetary policy. The median rate is the level that gets reported more often than not as it does represent a middle ground in Fed thinking, but it is a long way from a consensus Fed view on where rates will be. Just look back at dot plots of old and the median projections often have little resemblance to what actually transpired.

Be that as it may, this is what the market focuses on in an age of fairly mundane Fed speak coming out of the meetings. This meeting, however, is likely to spark quite a bit of interest and volatility. Powell’s unequivocal hawkish pivot in congressional testimony a few weeks ago sets the stage for the Fed to follow through with projections that reflect a concern for inflation over the employment mandate and that could, or should, be reflected in a more aggressive rate-hiking posture presented today. So, two hikes in 2022 seems a good start but do they ramp that up to four in 2023 versus the prior forecast’s three hikes? Again, we think that is reasonable given the multi-decade highs in recent inflation readings, along with decent consumer consumption numbers despite their more dour consumer confidence readings.

One thought of late that has been circulating is with the Treasury curve already so flat, would they dare hike us into an inverted curve? There was much consternation about that very thing in the last hiking cycle, but that was with 1.5% core inflation. At over 4% core such inverted curve concerns could be backburner stuff now.  Some officials have talked about selling down the Fed‘s balance sheet to build some yield into the longer end. These are not 2022 problems, but issues the Fed will likely discuss today and be pondering as they move a step closer to the first rate hike.

Copper/Gold Ratio Signals Little Concern with the Latest Virus Variant

This is our quarterly check-in with the Copper/Gold Ratio versus 10yr Treasury yields as one tell on the future direction of interest rates. We also like to check in on the ratio because it does provide signals as to future global growth projections as well. Copper is used in so many facets of modern economies that its price is a decent reflection of global growth expectations. With all the hubbub around Omicron and the potential to slow both developed and developing economies, we thought we would check in on the ratio to see if it’s starting to reflect a slowing global growth outlook.

Source: Bloomberg

As the graph shows, the last year of trading in copper has been decidedly rangebound with a few spikes higher but with little evidence of a declining trend either. The recent retreat from the latest spike probably reflects some concern over the Omicron variant spreading into numerous regions of the world. With the UK planning to reinstitute work-from-home protocols for those that can, there is some concern that supply bottlenecks and some slowing in  consumption could develop again, and that is reflected in the recent dip in copper, but a more definitive downtrend is not evident either.

That lack of concern over a slowing economy brought on by the Omicron variant is also evident in recent Fed comments. In testimony to the Senate Banking Committee a few weeks ago, Chair Powell expressed more concern over the inflation-inducing impact of the virus versus the economic/labor market impact. That was essentially the path they took in regards to the Delta variant and it proved to be the right course of action so we expect them to follow the same course here.  The lack of an uptick in Treasury yields probably reflects both a slight slowing in growth prospects and the Fed’s  inflation-fighting intentions.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.67 1.04 1.26 1.52 1.98 2.45
0.50 0.66 1.02 1.20 1.41 1.84 2.34
1.00 0.65 0.99 1.17 1.37 1.75 2.21
2.00 0.97 1.11 1.29 1.63 NA
3.00 1.25 1.57 NA
4.00 1.52 NA
5.00 1.49 NA
10.00 NA

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Published: 12/14/21 Author: Thomas R. Fitzgerald