Federal Reserve Snapshot: A nod to November


(MENAFN – ING) Covid-related caution and lack of employment data means the Federal Reserve will leave its policy on hold next week, but with inflation remaining high and growth prospects remaining good, we we expect more explicit recognition that QE reduction will begin this year

In this article

  • Fed on hold due to Covid cautiousness and weak jobs
  • The cone is approaching – expect an announcement in November
  • Dot plot with thumb towards previous hikes
  • Tariff increase planned for the end of 2022
  • The impact on the market will probably be most acute during a shuffle of points
  • FX: Dust off the June Playbook

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Subscribe to THINK Fed on hold due to Covid cautiousness and weaker jobs

A decision not to change at the next FOMC meeting seems to be a given. The federal funds target range will be held at 0-0.25% and monthly asset purchases held at $ 120 billion per month despite decent activity data and high inflation readings reaching double the l The Fed’s 2% target.

Just six weeks ago, that wasn’t necessarily going to be the case. Several regional Fed chairmen openly questioned the need for quantitative easing, most notably St. Louis Fed Chairman James Bullard, who argued that “it is not clear to me that we are doing this. really something useful here ”. Dallas Fed Chairman Robert Kaplan agreed, stating that “these purchases are not well suited to the environment we find ourselves in now… I think the best thing to do is to start weaning early on this. medication “. Several others said it was at least “appropriate” to start the discussion on “recall” of the stimulus.

New Fed Forecast

Federal Reserve, ING

However, the Jackson Hole Symposium that followed showed the Governing Council to be more cautious given the Covid resurgence as Fed Chairman Jerome Powell made it clear he wanted to see more progress on the employment aspect of their mandate.

He argued that “we have a long way to go to reach maximum employment” and with 5.3 million fewer people than in February 2020 and clearly disappointing August wages (235k vs. the consensus of 733k ), majority opinion at the Fed came back in favor of delaying a cutback decision until there was better news.

The cone is approaching – expect an announcement in November

As Covid cases appear to be peaking and the job market constrained more by a shortage of workers than a slowing demand, we believe the announcement of the QE cut will come in November. For now, all we can expect is cautious optimism in the statement with somewhat more explicit support for this year’s reduction in Jerome Powell’s press conference. We also expect him to point out that this move is completely separate from any rate hike decision – there is no automatic path to higher interest rates.

Dot plot with thumb towards previous hikes

The new Fed forecast will show a slight downward revision in growth with an upward revision in inflation. The big story could be the Fed’s individual forecasts for interest rate hikes. Currently, 7 out of 18 officials are aiming for 2022 as the starting point for increases and we could maybe see one or two more push their forecasts up to 2022. We suspect the median remains at 2023 for now, but it will be. a tight call.

Federal Reserve dot chart for where the target federal funds rate is heading

Macrobond, ING
Tariff increase planned for the end of 2022

We continue to believe that the reduction will be carried out swiftly, starting in December and ending in about six months with asset purchases reduced proportionally between treasury bills and agency MBSs of $ 20 billion per month. There will then be a gap, but with the economy’s supply capacity expected to remain constrained by bottlenecks and labor market shortages, we believe that a strong demand environment with high inflation means the Fed will start raising interest rates from the end of 2022. Acting sooner will mean lower the terminal federal funds rate – we see it peaking at 1.5% versus the 2 digit , 5% projected by the Federal Reserve.

The impact on the market will probably be most acute during a shuffle of points

The rate market will focus on three things. First of all, on any suspicion of an impending cone. Second, on any points shuffle. Third, on any fine in repo transactions. The first concerns the back-end. While a cut announcement is not expected, any nod to it would likely push up long-term rates. The second is more of a frontal influence. Currently, the 2-year yield in the 20bp area contains only minimal upside risk, and this extends through Q3 2023. Bring the point forward one year and this haircut by 2 years seems wrong. Upward pressure on the 2-year yield should be exerted. It is the most likely outcome of this meeting to have a significant effect.

The third element concerns the technical aspects of money market liquidity. The Fed doesn’t systematically comment on this, but given the persistence of USD 1 tr per day entering the reverse repurchase facility overnight, this is something that can be resolved. The tone so far is that it is nothing less than what the Fed expected, and that it is acting like the safety valve it was meant to be. Where we’re going in terms of excess liquidity is partly out of the Fed’s control. To the extent that the US Treasury has practically spent its balances with the Fed downward, the upward pressure on volumes is reduced. At the other extreme, the debt ceiling prevents the depletion of liquidity by issuing bonds.

Then there’s the planned permanent pension facility that the Fed is currently tweaking. This is something that will come to the fore when the Fed cuts down and finally takes reserves from the system. Here, the Fed would add liquidity (instead of draining it like it does with the repo facility). The biggest debate here is over the eligibility of counterparties, where as wide a net as possible would minimize potential future pressures. At the same time, there is a body of opinion that suggests limiting this to domestic insiders. This is unlikely to become a major talking point at the press conference, but it will likely be in the next few minutes.

FX: Dust off the June Playbook

As above, it will be any Fed Dots adjustment that will have the greatest impact on the currency and money markets. The June 16 FOMC meeting proved somewhat shocking for these markets, where the shift to a median expectation of a rate hike in 2023 saw the OIS rate of USD 1 million valued at two years up. by 15 basis points and the dollar broadly rebounding 1% overall.

The biggest currency losers on June 16 in the G10 FX space were the Norwegian krone (-2%), the Swedish krona (-1.5%) and in the emerging markets space, the South African rand and the Mexican peso, both down 1.8%. The Japanese yen (-0.5%) and the Chinese yuan (+ 0.13%) notably outperformed.

As this meeting approaches, speculators remain a bit long in dollars. The most stretched long dollar positions are seen against the Australian dollar and, to a lesser extent, the yen. Certainly, the JPY’s outperformance on the crosses would be a popular transaction if the median Fed Dot moved to 2022 – which would likely hit stock markets with both lower earnings expectations and higher discount rates.

The June experience really saw a high beta exchange rate and of these we believe the rand would be the most vulnerable at a hawkish Fed meeting on Wednesday. That’s because it doesn’t have the interest rate protection of some of its emerging market peers, and doubts may soon emerge as to the longevity of its current account surplus.

But as mentioned above, a move to a 2022 median rate hike is far from certain and whether the FOMC meeting can go without much fanfare, a dollar neutral environment and a EUR / USD neutral environment in a Low volatility context may see continued demand for these currencies sustained. by hawkish central banks. This will favor NOK in the G10 space (Norges Bank will rise 25bp on Thursday). And in the Central and Eastern European space, it will favor currencies like the Hungarian forint and the Czech crown, both backed by central banks which are expected to rise by at least 25bp over the next fortnight.

Key words
US Type QE Interest rate Federal Reserve share

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