Interpreting CME Fed Watch and benchmark yields
The CME Fed Watch chart above assigns probabilities to possible rate hikes over the next few FOMC meets. It captures the next four Fed meets that are to take place during 2021. The probability of status quo continues to remain above 85% well through 2021, which indicates a very low probability that the Fed may renege on its commitment and hike rates. The Fed Watch Tool is based on yields implied in Fed futures prices so it has a strong market expectation flavour.
The other aspect is that of benchmark bond yields for 10-year maturity. That has remained stable around the 1.61% mark and the FOMC statement did not have any amplifying impact on the yields. However, yields have rallied from a low of 0.51% in July 2020 to 1.76% in April 2021. The possible Fed hawkishness may already be factored into bond yields.
Key takeaways from the FOMC statement
Even as the US Federal Reserve remained steadfast on supporting the liquidity levers, the statement has some very subtle shifts that could have larger ramifications for the global markets and also the way India conducts its monetary policy. Here is a quick dekko.
a. The US Fed has committed to keep short-term interest rates anchored in the range of 0.00% to 0.25%. This is the lowest possible level that the Fed rates can be maintained at without consciously allowing the rates to dip into negative, as many of the European central banks and the BOJ have done.
b. The Fed has also committed to sustain its bond buying program at $120 billion of bonds per month. In the last few months, the Fed has been increasingly buying mortgage bonds to avoid holding too much of treasury debt. It is also true that this bond buying has resulted in the Fed balance sheet bloating to close to $8 trillion.
c. If all this appears like a repetition of previous FOMC statements, there is a stark change too. For the first time, the FOMC statement has officially admitted that there was palpable improvement in economic strength as well as a rise in inflation. The Fed has underlined that it has deliberately chosen status quo on rates and bond buying despite macro signals to the contrary. This acknowledgement is the big shift.
d. The gist of the Fed stance was captured by the Fed Chair, Jerome Powell. According to Powell, the headline inflation and growth numbers do not give the full picture. For example, the growth recovery has been extremely uneven and the accommodative policy was needed to bring about parity in growth. Secondly, inflation spike appeared to be an outcome of supply side bottlenecks owing to the pandemic. Hence, the current inflation number may not be representative as it would taper with the constraints.
e. As important aspect of the statement was that it acknowledged that the economic activity was largely boosted by strong policy support and the massive vaccination drive, with more than 3 million being vaccinated daily. However, it was unclear if the growth would sustain on its own legs. Fed underlined the need to stay accommodative till US growth acquired its own momentum.
To sum up the FOMC statement, they may still be right on growth despite flattering March quarter numbers expected. However, the bigger concern is inflation with March consumer prices rising at 2.6%, the steepest since Aug-18. Also, markets are factoring in a 5-year average inflation rate of 2.5% compared to just 0.8% one year ago. It is not growth, but inflation that would test the Fed’s resolve in holding rates and liquidity infusion targets.
This is largely what RBI has also been saying
Like in the US, India also has a problem of rising inflation and uneven growth recovery. RBI, in its latest monetary policy in April, maintained status quo and restricted itself to flagging the inflation risk to rates. However, what the Fed says appears to justify what the RBI has also been saying about inflation being driven by supply push, rather than by demand pull.
For the RBI, this FOMC statement simplifies its immediate task. The general approach has been to maintain broad monetary alignment between Indian and US monetary policies. For now, it looks like rates will remain low and liquidity will remain comfortable. That should be good news for the financial markets.