Posted by lplresearch

Thursday, January 27, 2022

The Federal Reserve (Fed) ended its two-day Federal Open Market Committee (FOMC) meeting yesterday and the outcome was broadly in line with the Fed’s recent hawkish shift. As expected, despite calls for a quicker exit, the Committee announced that the monthly asset purchase programs would end in “early March.” Also, the Committee indicated that, due to persistent inflationary pressures, a rate hike may soon be appropriate. Finally, the Fed also indicated a willingness to start shrinking its nearly $9 trillion balance sheet, but that process would start after interest rate liftoff and through a predictable manner. While details on rate hikes and balance sheet runoff were scarce, Chairman Jerome Powell noted that “the FOMC is of mind to raise rates at the March meeting”. Powell said the Committee will be turning its attention to the details on the balance sheet contraction process in subsequent meetings but would likely begin in the second half of the year.

“The hawkish shift we heard in December was further confirmed at this meeting,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “The Fed wants the public and markets to know it is serious about arresting high consumer prices, as best it can. It will be interesting to see, though, how much of this is trying to manage expectations through forward guidance and what is actually going to happen.”

While most of the details provided were consistent with market expectations—a point Powell made by saying the communications with the public and markets are “working”—there were some details that implied the Fed could move faster than expectations. As shown in the LPL Chart of the Day markets expectations for rate hikes increased after the meeting and are now pricing in more than four rate hikes this year.

The genesis of the move higher in expectations likely came from Powell’s comment that the Committee believes there is considerable room to raise rates “without threatening the labor market”—a fairly bold assertion from Powell who is generally cautious with his comments. Moreover, Powell refused to rule out raising interest rates at every FOMC meeting this year (there are seven remaining) versus the expected quarterly rate hiking schedule that was priced in previously. We’re likely to hear more details from Fed speakers in the coming weeks but the next scheduled FOMC meeting concludes on March 16 and the meeting minutes from the January 25 meeting will be released in three weeks.

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