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‘The beginning of the transition’: Investors react to the Fed with less pessimism


The Federal Reserve has for months been wary of signaling that the end of its pandemic-induced loose monetary system was imminent: the virus was still lurking, the recovery was too fragile, and uncertainty was rampant.

On Wednesday, the moment the Federal Reserve might start to abruptly end its support appeared on the horizon.

Jay Powell and his fellow Fed officials took a much more optimistic view of America’s recovery—and thus paved the way for a drift toward tighten policy.

Not only did the Fed start talks on reducing the pace of its $120 billion per month asset purchase program, but US central bank officials’ economic forecasts revealed that most now expect a double-digit rate hike in 2023, a year earlier. Expect only three months in advance.

“There is a very sharp shift in the Fed’s approach to managing the recovery here,” said Tim Doe, an economist at SGH Macro Advisors and the University of Oregon. “The weight of evidence that the economy is recovering faster than expected, with more inflationary pressures than expected, finally broke the Fed’s pessimistic stance.”

During his press conference, Powell sought to explain the changing opinions among his colleagues. “Many participants feel more comfortable meeting economic conditions in the committee’s future guidance somewhat sooner than previously expected. That would be a welcome development.”

Federal Reserve officials, according to median forecasts, expect the US economy to grow by 7 percent this year, and 3.3 percent in 2022, with the unemployment rate falling to 3.8 percent by the end of next year, from 5.8 percent. cent in May. But they stick to their view that the economy will not warm up: core inflation will jump to 3 percent this year, but fall to 2.1 percent in 2022 and 2023 — a scenario the Fed sees as consistent with a full recovery.

The optimistic forecast brought cheers from the Biden administration, which it called evidence that its economic policies, including massive fiscal stimulus, were working. “It’s a demonstration of the effort to be bold, to be decisive and to act broadly and quickly,” a White House official told the Financial Times.

But some investors were unstable.

“The big picture here is that this is the beginning of the transition from truly accommodative monetary policy to monetary policy that will be less accommodative,” said Michael Collins, senior portfolio manager at PGIM Fixed Income. “We will start tapering off and then there will be some price increases, and I think the market will have a hard time adjusting to that. It will lead to more volatility.”

The shift in the so-called dot plot of the Fed’s interest rate expectations is certainly shake $21 trillion in the government bond market. Treasuries of all maturities sold off sharply after the issue, driving up yields.

The benchmark 10-year yield rose 0.08 percentage points before paring some of those losses on Thursday to settle around 1.55 percent. The five-year bond traded 0.12 percentage point higher at 0.895 percent and has regained strength slightly since then.

The two-year bond yield, which is more sensitive to the timing of the Fed’s rate hike and hasn’t budged a bit so far this year, also jumped to hover around 0.2 per cent.

The Fed’s reference to the possibility of two card rate increases in 2023 was “surprising,” according to Michael Stretch, chief investment officer at BMO Wealth Management, although some market expectations metrics have already suggested such a shift.

“One would have been enough . . . and two exclamation points,” Stritch said, noting that the number of Fed officials in a move early next year is now higher than they were in March, even if they are still in the minority.

“This means that the timeline has been shortened very dramatically… It is not inconceivable that a rate hike in 2022 would be effective.”

Feeding point plot gif updated with June 16th meeting

Roberto Burley of Cornerstone Macro was also surprised, saying the Fed had “closed its eyes”, turning its back on its pledge to change policy only based on apparent economic improvements.

“One score could not have surprised us too much, but two is indeed a big step for a committee that has so far been adamant in sticking to its new framework and consciously unwilling to respond proactively to changes in expectations,” Burley wrote in his note.

During the press conference, Powell attempted to dispel notions of a rapidly accelerating timetable toward monetary tightening, saying that the dot chart should be taken with a “grain of salt,” risks from the virus still exist, and any policy changes that would happen step by step.

The Fed has pledged to continue buying agency Treasury securities and mortgage-backed securities at the current pace of $120 billion per month until it sees “substantive additional progress” toward its goal of a more comprehensive recovery. Only later did interest rates increase, after achieving certain economic milestones.

“The committee’s focus is on the current state of the economy, but in terms of our instruments, it’s about asset purchases, and that’s what we’re thinking about. He leaves [in interest rates] Powell said. “It’s great to see the progress but, again, I won’t declare victory yet.”

The change in attitude could help defuse criticism from some economists that the Fed risks being behind the curve in setting policy, something that could mean it later has to squeeze the brakes.

If the Fed sits here and says there’s nothing to see here and we’re not worried at all [about inflation]”I think her credibility is starting to come into question,” said Lisa Hornby, head of US multi-sector fixed income at Schroders Asset Management.

We can’t continue to live in this world where the Fed sets interest rates at zero and buys $120 billion مليار [government] securities in the month and we have a very strong growth outlook.”



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