More Hawkish Fed Talk Expected Today

The Fed concludes its two-day meeting this afternoon, with a statement at 2pm ET and a Powell-led press conference at 2:30pm ET. We discuss in more detail below what we expect to hear coming out of the meeting, but suffice it to say we expect the statement and Powell’s presser to continue the hawkish theme that began in December. Selling in equities, while harmful to most of our 401(K) positions, won’t deter Powell from staying on message about wrestling inflation to the ground.

Thus, the Powell put won’t be in play today.  That is, they aren’t likely to soften their anti-inflation message before the first rate hike is even in place. Therefore, expect more bouts of equity selling, and volatility, before the hawkish rhetoric softens.

What Are We Likely to Learn This Afternoon?

With the FOMC meeting concluding this afternoon, we wanted to kick-off the morning with what we expect to see, and we’ll follow that up with a quick recap following the decision this afternoon. For now, however, let’s review what we expect to hear from the Fed in the statement, and from Chair Powell in the post-meeting press conference.

  • First and foremost, while the statement won’t shed much detail on future rate hikes, Chair Powell in the press conference is likely to not push back, or otherwise disagree, with the current market outlook for four 25bps hikes this year, beginning in March.
  • The statement is likely to upgrade the economic outlook, and generally prepare the market for the aforementioned rate hike in March.
  • The statement is also likely to discuss the balance sheet. With quantitative easing (net purchases increasing the size of the balance sheet) set to end in March, investors want to know what will happen to the existing stock of bonds sitting in the $8.8 trillion balance sheet. There is likely to be a discussion that with balance sheet purchases ending, that run-off of the balance sheet will begin sometime in the third quarter. That is, they will slowly start to let returning principal (via prepayments, calls and maturities) not be reinvested. This is likely to be a slow process, just like QE tapering, but the balance sheet will start to decline in size at some point in the third quarter.

If all of these parameters are hit without too much disagreement, either in the statement or in Powell’s post-meeting press conference, Treasuries may well rally.  But, if there is a more hawkish tone, say signals of a 50bps hike in March, then volatility will return and yields are likely to rise further. Signals too of a possible selling down of the balance sheet later this year would invite more Treasury selling today. We don’t foresee those signals but we await today’s press conference for confirmation.

Financial Conditions Tighten But Still Plenty of Room to Tighten Further

It’s almost axiomatic that when the Fed begins to remove policy accommodation that financial conditions start to tighten. But to have those conditions tighten even before the Fed has removed any accommodation is where the market is doing some of the Fed’s work, and they would no doubt like that. Just with the mere expectation that rate hikes are coming stocks have sold off, yields have risen and that has tightened financial conditions as shown below in the Goldman Sachs Financial Conditions Index.

Source: Bloomberg

But while 2022 has no doubt been rough to risk assets, and to Treasury yields, there is still plenty of tightening in financial conditions that can happen.  As the graph shows, we’re still below the peaks of last March when Treasury yields lifted throughout the first quarter, touching what would prove to be 2021 calendar-year highs on March 31.

So, while financial conditions have tightened before the first rate hike, something the Fed will welcome, don’t expect soothing words from Powell this afternoon that he’s worried for your stock portfolio. Not yet, anyway. But we will say that watching unrealized stock gain turn to losses will have an impact on future consumption, but that is a story for another day, perhaps after the first or second rate hike.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 1.06 1.35 1.58 1.87 2.32 2.78
0.50 1.04 1.33 1.52 1.75 2.18 2.67
1.00 1.04 1.29 1.49 1.71 2.09 2.54
2.00 1.28 1.43 1.63 1.97 NA
3.00 1.59 1.91 NA
4.00 1.86 NA
5.00 1.83 NA
10.00 NA

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Published: 01/25/22 Author: Thomas R. Fitzgerald