• Now that the FOMC meeting has come and gone, and the Treasury and equity markets have resumed their selling as a consequence, let’s take a look at those forecasts and see what they might tell us.


  • A year ago, the Fed was declaring rates would be lower for longer, and that they wouldn’t be tightening rates until 2024, at the earliest. They believed a recession wasn’t likely, and that inflation is transitory and not a problem.  Inflation should fall to 2.0% in 2022.


  • And now we have a completely different forecast with the Fed already well into a hiking cycle with the latest guess for a terminal rate being 4.50% -4.75%, and keeping it there throughout 2023.


  • This is not to beat-up on the Fed per se, but to say in general forecasting is very tricky right now. Think about all the one-off factors that have impacted the economy in the last two years: pandemic, lockdowns, easing lockdowns, fiscal stimulus programs, supply chain problems, Russian invasion of Ukraine, and now a Fed that is furiously raising rates from 0% to 4.5% in just over a year. Good luck getting all those factors right.


  • The larger point is that forecasts right now should be treated with a fair degree of suspicion, even from the Fed and the battery of PHD economists they have at their disposal.


  • Clients can be excused for thinking that they can very soon sit back and clip a 4.5% fed funds rate for more than a year, so why do anything in the bond portfolio?


  • That would be ok except for two factors: how confident should we be with the Fed’s latest forecast given their track record? The second factor is most banks are asset sensitive with greater risk to falling rates. While that is not a risk today, it will be at some point. The issue is nailing down the when. Everything in this cycle has happened very quickly and we suspect these rapid series of 75bps rate hikes will quickly impact the economy as well.


  • When it becomes obvious to all that the next move by the Fed will be a rate cut, longer-end yields available today will be much lower. The fixed income market is a tremendous anticipatory machine, and it will do the same when it sniffs the first signs that the Fed is shifting position.


  • The bottom line is that the Fed’s forecast a year ago bears little resemblance to what actually happened and while they may have it right now, one has to wonder if the forecast six months from now will also be different than the one on Wednesday.


2yr – 10yr Treasury Spread – Signaling  Recession

Source: Bloomberg


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 4.19 4.26 4.26 4.26 4.27 4.73
0.50 4.17 4.22 4.23 4.15 4.13 4.62
1.00 4.17 4.19 4.20 4.11 4.04 4.49
2.00 4.18 4.18 4.03 3.92 NA
3.00 3.98 3.86 NA
4.00 3.81 NA
5.00 3.77 NA
10.00 NA

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Published: 09/23/22 Author: Thomas R. Fitzgerald