Investors are looking for clues about interest rate hikes

Federal Reserve Chairman Jerome Powell testified during a hearing in the Senate Banking, Housing and Urban Affairs Committee on the CARES Act in the Hart Senate Office Building in Washington, DC, USA, on September 28, 2021.

Kevin Dietsch | Reuters

This week, the Federal Reserve is widely expected to announce the winding up of its monthly bond buying program – a measure it launched to support the economy during the pandemic. The biggest story for the markets, however, is how the central bank will discuss inflation.

This is because report after report of warmer-than-expected inflation has raised expectations that the Fed will combat the trend of higher prices by starting to raise interest rates next year, about six months earlier than the latest Federal Reserve forecast.

Economists expect the central bank to say, after its two-day meeting on Wednesday, that it will begin settling its $ 120 billion in monthly bond purchases in mid-November or December and end the program by the middle of next year. .

Fed Chairman Jerome Powell has made an effort to stress that the end of the program does not signal the start of a new rate hike cycle, and he is expected to repeat this message at his briefing after the meeting on Wednesday.

But already traders are pricing more than two rate hikes for next year, while the majority of Fed officials do not even see one in 2022 in their latest forecast. This is because inflation, now at its peak in 30 years, has warmed up and appears to be lingering longer than the “transient” or temporary description that the Fed had included in its recent policy statements.

“My feeling is that the word ‘transient’ has left the station. I would be shocked if we heard that word come up again,” said Rick Rieder, investment manager for global interest rates at BlackRock. He said it would be important to see how the Fed addresses employment, the other half of its dual mandate.

Rising inflation and wages

Inflation, measured by the Private Consumer Expenditure Index, rose 0.3% for September, driving year-on-year gains to 4.4%, the fastest since January 1991.

Companies struggling to find labor are also raising wages to retain and attract employees.

“I think it’s the hottest job market since World War I,” Rieder said. “We had the highest [employment cost index] print since 2004. Wages are accelerating dramatically and I think the Fed is lagging behind. I think they need to open the window to raise interest rates. “

Rieder said he does not expect the Fed or Powell, in their post-meeting briefing, to discuss raising federal funds interest rates from the current zero level. The federal funds interest rate set by the central bank is the interest rate that banks borrow and lend to each other overnight.

“There is clearly movement in the direction of the Fed recognizing that inflation is more sticky than they thought it would be,” Rieder said. “I think [Powell] will present data … that they expect some of these inflation figures to fall, and I think he is right. “

But Rieder said the Fed needs to show it would be willing to raise interest rates if it had to. According to CME’s FedWatch Tool, traders see a 65% chance that the Fed will start raising interest rates by a quarter of a point in June and a 50% chance of a second increase in September, with a third also possible.

Relaxation is the first step

The Fed took unprecedented steps to quickly ease policy when the pandemic hit in early 2020. The Fed quickly lowered interest rates to zero and the bond buying program was launched to quickly provide liquidity to the markets.

Downsizing bond purchases or quantitative easing will be the first relaxation in a larger program. The Fed is widely expected to detail that it will slow its $ 10 billion-a-month Treasury purchases and $ 5-billion-a-month mortgage bonds.

A wild card for the Fed has been Covid itself, and the outbreak of the delta variant is widely blamed for the sharp slowdown in growth in the third quarter. Gross domestic product grew by only 2%, only a quarter of what some economists expected for the period earlier in the year. While the Fed is likely to recognize slower growth, economists see that it is already heading up again in the current quarter.

Mark Cabana, head of the US short-term interest rate strategy at Bank of America, said there is a chance the Fed could say it can speed up or slow down its downsizing process as needed.

If the central bank talks about increasing the pace, as some Fed members had opted for a faster rollback at the last meeting, it could affect the market. “It just increases the risk that the Fed will end up sounding hawkish,” Cabana said.


Powell is unlikely to talk about raising interest rates, but he is also unlikely to discourage market pricing of rate hikes.

“The first rate hike is priced until July … It’s too early for the Fed to push the hikes back. He will not tell the market that it is wrong,” Cabana said. “There is an upward inflation risk. They do not know for sure how inflation will develop.”

Rieder said he doubts Powell would talk about the potential for downsizing faster. “My feeling is that it is not being considered today, but if he said we could step down faster, then the markets would interpret it as they are considering raising interest rates faster and / or more aggressively,” he said.

But no matter what Powell says about the link between downsizing and bond buying, the market’s main interest is inflation and the interest rate movements it can trigger.

Diane Swonk, chief economist at Grant Thornton, said she expects the Fed will be forced to raise interest rates next year.

“Our own forecast has core PCE … peaks above 4% by the end of the year and declines to 3.5% by mid-2022. Unemployment is expected to dive below 4% in the first half of 2022,” Swonk noted. “These shifts would lead to faster downsizing and faster rate hikes than the Federal Reserve posted in its September forecasts. Market participants are now expecting three rate hikes next year; we could see more.”


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