The Federal Reserve (Fed) ended its two-day Federal Open Market Committee (FOMC) meeting yesterday and the outcome was broadly in line with market expectations. As expected, the Committee raised short-term interest rates by 50 basis points (0.50%) and “anticipates that ongoing increases in the target range will be appropriate”. The 50 basis point hike was the largest rate hike since May 2000. Additionally, the Committee announced balance sheet normalization would begin June 1 with initial reinvestment caps at $47.5 billion for the next three months until fully reducing Treasury and mortgage securities by $95 billion per month beginning in September.
The Fed continues to believe the economy enjoys strong momentum and is well positioned to handle the removal of monetary accommodation. And that, despite the overall dip in economic activity in the first quarter, “household spending and business fixed investment remain strong”. Moreover, during the press conference, Chairman Jerome Powell reiterated the Committee’s belief that it can achieve a “soft or soft-ish” landing and that there is a “plausible path” to avoiding a recession. Importantly, the Committee acknowledged that inflation pressures remain elevated but the Committee is “highly attentive to inflation risks”. As such, of the Fed’s dual mandate of maximum employment and price stability, it remains clear that the Fed is, and will likely continue to prioritize containing inflationary risks in the near term.
“Fed Chairman Powell calmed some of the market’s nerves by pushing back some of the more aggressive market expectations noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Equity and bond markets were pricing in a pretty aggressive rate hiking campaign so the potential for the Fed to be less aggressive than markets are expecting was a welcomed change and both equity and bond markets responded positively.”
While most of the details provided were consistent with market expectations, Powell seemingly took a potential 75 basis point hike off the table (which markets were increasingly expecting at the June meeting) by saying that “isn’t something the FOMC is actively considering”. That comment helped drive stock prices higher and Treasury yields lower. As shown in the LPL Chart of the Day, after drifting higher throughout the day, 2-year Treasury yields, which tend to be more sensitive to changes to monetary policy, fell dramatically after Powell’s comment.
We continue to think the Fed will front-load rate hikes with another 50 basis point hike at its June meeting and then continue to raise rates by 25 basis points at each of the next three meetings before potentially skipping a rate hike in December. Our base case remains that the Fed funds rate will end the year at 2.25%, which if realized and given the more aggressive market expectations, should provide a boost to both equity and fixed income markets.
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