This article was originally published on ETFTrends.com.
By Kevin Flanagan
Head of Fixed Income Strategy
In what was expected to be a relatively uneventful Fed meeting a few short days ago, the June FOMC gathering turned into a headline-making event instead. The voting members raised Fed Funds by 75 basis points (bps) to a new target range of 1.50%–1.75%. This was the first 75-bp rate increase since 1994. With this latest move, the voting members have hiked rates by a total of 150 bps over the last three months. However, the narrative of future rate hikes has now been potentially tilted to the upside following the surprising increase in inflation in the May CPI report.
Following the rout of the money and bond markets post the aforementioned CPI report, “autopilot” monetary policy has just been turned on its head. While the current two-tiered policy approach (rate hikes and quantitative tightening (QT)) is essentially unprecedented and takes not only the Fed but also the markets into uncharted waters, now the future magnitude of rate increases has “clouded” the journey even more.
The term “data dependent” has been, and will continue to be, the “hot button” phrase. In addition, the Fed will be monitoring financial conditions closely. That being said, at the present time, Powell & Co. are without a doubt placing fighting inflation as their primary, if not only, concern. In fact, unless the economic data and/or financial conditions completely fall apart, it is difficult to envision the policy makers letting up “on the brakes” any time in the foreseeable future.
Actually, given how “far behind the curve” the Fed was to start this tightening cycle, it definitely had some catching up to do. Hence, the emphasis of late on 50-bp, and now 75-bp, rate hikes. Powell’s stated goal has been to get to “neutral” “expeditiously” in terms of the Fed Funds Rate. Now, the debate will turn to monetary policy becoming restrictive as we move forward.
As we’ve seen this year, especially lately, the situation surrounding monetary policy remains a fluid one. Just within the last month or so, market expectations shifted from 50-bp rate hikes to the Fed pausing its rate increases due to potential recession concerns, but now 75-bp rate hikes are all the rage. It is important to keep in mind that QT can be akin to rate hikes as well, and policy moves act with a lag, further clouding the outlook.
As I mentioned previously, by implementing this two-pronged policy-tightening approach, the Fed is taking the bond market into uncharted territory. What we do know is that the Fed is determined to take rates to higher ground. While Treasury yields have already risen in a visible fashion year-to-date, Powell & Co. have now begun to put their words into action, keeping rate risk elevated accordingly. Against this backdrop, we continue to recommend that fixed income investors position their portfolios for further increases in interest rates going forward.
Originally published by WisdomTree on June 15, 2022.
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