Looking ahead to the much anticipated decision from the US Federal Reserve (Fed) later today, Brendan Murphy, Head of Core Fixed Income, North America, Insight Investment, shares his analysis as follows:
- We will be paying particular attention to the so-called Fed “Dot Plot” to try to gauge policymakers’ expectations for both where the terminal Fed Funds rate might be and how quickly they may be willing to reverse course and begin cutting rates. The most recent dot plot would imply a Fed willing to continue hiking a bit more and leaving rates elevated throughout 2023. Market pricing, however, implies a Fed that will need to reverse course relatively soon and begin cutting rates in the second half of 2023.
- The dispersion in the dots, which is already quite wide in 2024 and 2025, will also be interesting as an insight into the level of uncertainty on the policy path. Market expectations have swung wildly since the last dot plot with stickier inflation numbers leading to talk of 6% terminal rates in February and early March while the more recent banking sector woes have led to a rapid repricing of those expectations lower.
- Two-year treasury yields peaked on March 9th at 5.07% and hit a low of 3.84% on March 17th. In that move of over 100bps lower in yield, the daily volatility was in excess of 20bps per day. It will be interesting to observe whether policy maker’s expectations are as volatile as the market has been or if the Fed is willing to look through the recent volatility and reiterate its commitment to keep policy rates restrictive until inflation is well under control.
- We believe the decision for this meeting will come down to a choice between leaving policy rates unchanged vs. a 25bp hike. Based on inflation data alone, the Fed would likely raise rates by 25bps but the recent market volatility could be an opportunity for them to pause at this meeting. The argument for a pause is strong as another 25bp increase could be seen as contributing to market volatility and financial instability. However, not delivering on 25bps might cause some to question the Fed’s resolve in bringing inflation lower which could create a whole new set of problems. Pausing may lead to an easing of financial conditions that work against their inflation goals.
- This is not an easy decision. If the Fed believes it has the tools to address banking liquidity and confidence issues outside of the policy rate decision, they may choose that route. The ECB decision last week to increase rates 50bps despite the banking sector concerns was interesting to note in this regard as a potential template for the Fed. We think they will deliver on the 25bps hike but the decision will be difficult. Market pricing is fairly evenly split between no hike and a 25bp hike.
