“Beginning of the transition phase”: Investors react to the less dovish Fed
For months, the Fed has been worried that it will signal the end of the ultra-loose monetary system triggered by the pandemic: the virus is still lurking, the recovery is too fragile, and the uncertainty is rampant.
On Wednesday, the moment the Fed may begin to reduce its support suddenly appeared on the horizon.
Jay Powell and his U.S. central bank officials have a more optimistic view of the U.S. rebound-hence the turnaround Tighten policy.
Not only did the Fed begin negotiations to finally reduce the pace of its $120 billion monthly asset purchase plan, but the economic forecasts of U.S. Central Bank officials show that most people now expect to raise interest rates by two levels in 2023, a year earlier than the same period last year. Forecast three months ago.
“The way the Fed manages the recovery has undergone a considerable shift,” said Tim Duy, an economist at SGH Macro Advisors and the University of Oregon. “The weight of evidence that the economy is rebounding faster than expected and inflation pressure is greater than expected has finally broken through the Fed’s dovish stance.”
In his press conference, Powell tried to explain the changing views of his colleagues. “Many participants are more satisfied that the economic conditions in the committee’s forward-looking guidance will be satisfied faster than previously expected. This will be a welcome development.”
According to the median forecast, Fed officials expect the US economy to grow by 7% this year and 3.3% in 2022, and the unemployment rate will fall from 5.8% to 3.8% by the end of next year. May minutes. But they insist that the economy will not overheat: core inflation will jump to 3% this year, but fall back to 2.1% in 2022 and 2023-the Fed believes this situation is consistent with a full recovery.
The bullish outlook made the Biden administration cheer, saying it was evidence that its economic policies, including large-scale fiscal stimulus measures, are working. A White House official told the Financial Times: “This is an endorsement of efforts to act boldly, decisively, and at scale and speed.”
But some investors are uneasy.
PGIM Fixed Income senior portfolio manager Michael Collins said: “The big picture here is that this is the beginning of the transition from a truly loose monetary policy to a less loose monetary policy.” “We will start with a reduction, and then there will be some interest rate hikes. , I think the market will have difficulty adapting. This will cause more volatility.”
The Fed’s so-called interest rate forecasting dot plot shift Bumps 21 trillion U.S. dollar government bond market.
After the release, Treasury bonds of all maturities were sold substantially, causing yields to soar. The benchmark 10-year Treasury bond yield rose by 0.08 percentage points to 1.575%, while the five-year Treasury bond yield rose by about 0.12 percentage points to 0.895%.
The yield on the two-year Treasury bond rose by 0.04 percentage points, which is more sensitive to the timing of the Fed’s interest rate hike, and has hardly changed so far this year. It is now hovering at 0.2%.
Michael Stritch, chief investment officer of BMO Wealth Management, said that the Fed’s indication that it may raise interest rates twice in 2023 is “surprising,” even though some indicators of market expectations have hinted at this shift.
“One is enough… Two are exclamation points,” Stritch said, noting that the number of Fed officials who are now expected to act as early as next year is higher than in March, even if they are still a minority.
“This means that the timeline has been greatly shortened… Increasing interest rates in 2022 is not unimaginable.”
Roberto Perli of Cornerstone Macro was also taken aback, saying that the Fed “blinked” and abandoned his oath to change policy only on the basis of a marked improvement in the economy.
“One level will not surprise us too much, but two levels are indeed a major move for a committee that has so far insisted on its new framework and deliberately does not want to react positively to the predicted changes. ,” Perli wrote. A note.
At the press conference, Powell tried to eliminate the idea that the monetary tightening timetable would be accelerated rapidly, saying that the dot map needs to be drawn with “a grain of salt”. The virus still has risks and any policy changes will happen step by step.
The Fed has vowed to continue to purchase U.S. Treasury bonds and agency mortgage-backed securities at the current rate of $120 billion per month until it sees “substantial further progress” towards achieving a more inclusive recovery goal. It will raise interest rates only after reaching certain economic milestones.
“The committee’s focus is on the current economic situation, but as far as our tools are concerned, this is about asset purchases, and this is what we are considering. [in interest rates] The future is promising,” Powell said. “It is great to see progress, but again, I will not declare victory yet. “
The change in position may help ease criticism from some economists that the Fed may be behind the curve in formulating policies, which may mean that it has to press the brakes later.
“If the Fed sits here and says there is nothing to see here, we are not worried at all [about inflation], I think their credibility is starting to be questioned,” said Lisa Hornby, head of US multi-sector fixed income at asset management company Schroder.
“We cannot continue to live in a world where the Fed has zero interest rates and bought 120 billion US dollars [government] For one month of securities, we have very strong growth prospects. “