Fed Watch: back to back in the history books

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Douglas Rissing

By Kevin Flanagan, Head of Fixed Income Strategy

The Fed did this in quick succession by raising the federal funds rate an additional 75 basis points (bps) at the July FOMC meeting. This brings the new target range to 2.25%-2.50%. Similar to last At the monthly call, voting members were faced with another higher-than-expected CPI ahead of their policy meeting and faced market expectation for a potentially even more aggressive move. However, unlike the June meeting, policymakers decided to maintain the “status quo” and not innovate by raising rates by a full percentage point.

With this latest move, the current Fed Funds target now matches the maximum range implemented during the last rate hike cycle that ended in late 2018. However, there is one big difference: the speed at which this target range has been established. In the last rate hike cycle, it took three years to get there, while the current scenario only took four months.

This brings us to another interesting observation. After implementing unprecedented policy measures to combat the adverse effects of the COVID-19 lockdown, the Fed has now arguably used unprecedented measures to bring down inflation. If my eyes are not mistaken, in the modern history of monetary policy, the Fed has never raised rates in consecutive increments of 75 basis points, leading to an incredible total of 225 basis points of rate hikes in just four months time. Think about it for a minute… as recently as March 15 of this year, the Fed Funds were still at “zero”! Yes, we’ve blogged before about the Fed’s “frontloading” of rate hikes, but that takes it to another level.

Oh, and don’t forget about quantitative tightening (QT). So far, this shrinking of the Fed’s balance sheet has gone unnoticed, just as Powell & Co. had hoped. At the time of this writing, the Fed’s holdings of Treasuries (UST), MBS and agency securities are down just $17.6 billion since the start of QT on June 1. position actually grew by nearly $19 billion. In other words, QT hasn’t really started in a visible way yet. According to the Fed’s “Plan to Reduce the Size of the Federal Reserve Balance Sheet,” the pace of QT is expected to pick up and reach peak monthly drawdown levels starting in September.

What can we expect for the rest of 2022? I’ve touched on QT before, and it should basically be on autopilot for now. Rate hike? This is an other story. On this front, the most important consideration is that the Fed should continue to raise rates at the last three FOMC meetings this year, the only unknown being by how much at each meeting. Powell & Co. are about as data-driven as I’ve ever seen in their decision-making process on this front. Given some of the recent data suggesting that a visible slowdown in the economy is already taking place, policymakers may decide to “reduce” the magnitude of rate hikes going forward and leave the Aforesaid QT “turn on” and do part of the lift. as well.

Conclusion

The final message is that bond market volatility has increased dramatically, with the 10-year UST yield exhibiting “whiplash” characteristics. Although the Fed will more than likely continue its rate hike path for the remainder of 2022, the unknowns presented by the direction the U.S. economy and inflation may take, and the Fed’s response thereto, should maintain the correspondingly high “volatility quotient”.

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Kevin Flanagan, Head of Fixed Income Strategy

Within WisdomTree’s Investment Strategy Group, Kevin is responsible for Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes content related to fixed income and travels with the sales team, organizes client meetings and provides expertise on existing bond ETFs and future of WisdomTree. Additionally, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was most recently Chief Executive Officer. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to Morgan Stanley Wealth Management’s Global Investment Committee, lead author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and worked with divisions of the firm’s Research and Advisory Group. to create asset allocation models for ETFs and fund managers. Kevin holds an MBA from the Lubin Graduate School of Business at Pace University and a BS in Finance from Fairfield University.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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