Fed hikes rates by 25 bps, promises to be more aggressive

17 Mar 2022 , 03:34 PM

When Jerome Powell had read out the Fed statement post the 26th January FOMC meet, he had indicated in no uncertain terms that the rate hikes would commence effective the Mar-22 FOMC meet. He had also underlined that the Fed aggression would predicate on inflation. Subsequently, US consumer inflation had spiked to 7.5% in Jan-22 and to 7.9% in Feb-22. Despite aggressive price rise, Fed restricted itself to just 25 bps rate hike in Mar-22 due to the geopolitical uncertainties surrounding the Russia Ukraine war.

Post the Mar-21 Fed meet announcement, the benchmark 10-year bond yields have settled nearly 45 bps higher since the Jan-22 meet at around 2.147% levels. Since Jan-22, the Dollar Index (DXY) has moved further up from 97 levels to the 98.37 levels, showing a lot of implicit dollar strength. With fresh bond buying already having tapered to zero levels, the 3 big questions ahead of the Mar-22 Fed meet were; the decision on the Fed rate hike, Fed rate guidance on future rate hikes and guidance on unwinding the Fed bond book. Let us start with the what is the CME Fed watch is indicating?

CME Fedwatch hints at aggressive rate hikes in 2022

One indicator of the probability of rate hike and its timing is CME Fedwatch. Here are the implied probability of different Fed rate scenarios over the next 8 Fed meetings.

Fed Meet	50-75	75-100	100-125	125-150	150-175	175-200	200-225	225-250	250-275	275-300
May-22	67.1%	32.9%	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil
Jun-22	Nil	23.5%	55.1%	21.4%	Nil	Nil	Nil	Nil	Nil	Nil
Jul-22	Nil	Nil	20.9%	51.7%	25.0%	2.3%	Nil	Nil	Nil	Nil
Sep-22	Nil	Nil	2.7%	24.9%	48.2%	22.1%	2.0%	Nil	Nil	Nil
Nov-22	Nil	Nil	0.6%	7.9%	30.4%	42.1%	17.4%	1.5%	Nil	Nil
Dec-22	Nil	Nil	0.1%	1.5%	10.6%	31.8%	39.2%	15.5%	1.4%	Nil
Feb-23	Nil	Nil	Nil	0.7%	5.2%	19.3%	34.8%	29.5%	9.7%	0.8%
Mar-23	Nil	Nil	Nil	0.26%	1.7%	8.3%	22.6%	33.6%	25.2%	8.4%

Data source: CME Fedwatch

Normally a probability in the range of 25% to 30% is a strong indication of affirmative action.

• With the first rate hike since 2018 implemented in Mar-22, the CME Fedwatch is hinting at one rate hike in each of the remaining 6 meetings in 2022.
• The Fedwatch is pegging rates at 200-225 basis points by Dec-22 hinting at the possibility of one rate hike being at 50 bps, instead of 25 bps.
• Clearly, it looks like the Fed has not been deterred by the prospects of an economic slowdown due to the ongoing war situation in Ukraine.
• Fed eventually expects the Fed rates to stabilize around the 275-300 basis points level, which would imply another 3 rate hikes post Dec-22, which could be spread out.

The above trajectory would be assuming that there is no large scale damage to growth or consumer demand that is visible due to the rate hikes.

What we gather from the Mar-22 Fed statement

The Fed statement by Jerome Powell on 16th March has clearly hawkish undertones and the fight is all out against rising inflation. Here are some quick takeaways.

a) The first rate hike by the Fed in more than 3 years marks a clear message that inflation at 7.9% was unsustainable. The Fed has indicated in the March FOMC policy statement that it had kept the rates at the 0.00% to 0.25% levels for longer than required.

b) Fed has pencilled in a rate hike of 25 bps in each of the remaining 6 Fed meets this year with an outside possibility of selective 50 bps hike if inflation worsens. Fed has underlined that this will spike consumer credit costs and curb debt-driven spending.

c) If we were to capture the gist of the March 2022 Fed statement, the repo rates would be closer to the range of 1.90% to 2.00% by Dec-22. This is 100 bps higher than the previous estimate. Also, Fed has hinted at 3 more rate hikes in 2023, with no rate hikes in 2024.

d) The only dissenting voice came from James Bullard, a member of the FOMC, who called for a 50 bps rate hike due to the consumer inflation veering towards 7.9%. However, the majority view was to play it cautious considering the geopolitical situation.

e) In an extremely hawkish indication, the Fed has added that it also proposed to start unwinding the $9 trillion Fed balance sheet from the May Fed meet onwards. The monthly buying of bonds has already been wound up as of March 2022.

f) The all-important Dot-Plot chart of Fed members indicates that 8 members expect more than 7 rate hikes in 2022 while 10 members felt that 7 rate hikes (including the March rate hike) would be sufficient.

g) While the FOMC expressed confidence in the ability of the US economy to handle the rate hikes, they did admit that the quarterly GDP could see a negative impact in the coming quarters. A lot would depend on how serious such a fall turns out to be.

h) For FY22, the FOMC has lowered its GDP growth projection from 4% to 2.8%. which is a substantial cut. However, they do not see unemployment going above 3.5%, which still shows an economy at virtual full employment.

i) Last year, when the Fed had stopped using the word “Transitory” to describe inflation, it was already clear that battling inflation would be the first priority for the Fed. That was really the theme of the Mar-22 Fed statement.

What the Mar-22 Fed statement means for India?

Essentially, the Fed statement means 4 things for Indian economic policy

• Rate hikes are happening much faster than expected. The world is turning hawkish and RBI cannot afford to be accommodative much longer.
• The RBI may have to look at a series of rate hikes, as early as this year, starting from the April policy. India cannot lag behind on monetary convergence.
• Equity outflows may be at record levels but debt outflows are still subdued. A combination of rising global rates and weak INR can be a recipe for debt outflows.
• More than anything, India will have to worry about the Fed book unwinding from May onwards. That will impact liquidity and passive portfolio flows.