Investment strategy
May 4, 2022
3 mins

Hawkish Fed on track to hike rates at least six times in 2022

May 4, 2022
3 mins
Bruce Harris
Head of Global Fixed Income Strategy
SUMMARY

The US Federal Reserve has delivered its largest interest rate hike in 22 years going back to May 2000, but it was one that the market fully expected. Following its latest move, we think the US central is likely to remain on track for at least 6 to 8 additional 25 basis points (bps) rate hikes in 2022, with next the hikes coming possibly in increments of 50bps.


  • As expected, the Federal Open Market Committee (FOMC) increased the Fed Funds rate by 50bps to 0.75-1.00%. The Committee also indicated that a heavy dose of additional rate hikes will be forthcoming for most of the rest of the year, stating that ongoing increases in the target range will be appropriate and that ;the Committee is highly attentive to inflation risks.
  • Balance-sheet reduction, also known as Quantitative Tightening (QT), will begin June 1st with approximately $47.5bn (combined between Treasuries and MBS) allowed to roll-off the Fed’s balance sheet. QT amounts will presumably be increased the following two months until they reach their caps sometime this summer of $60bn in Treasuries and $35bn in MBS ($95bn in total/month).
  • The FOMC statement did not explicitly reference the continuing drop in equity valuations, instead noting that overall financial conditions remain accommodative. The statement acknowledged the uncertain state of the economy, noting that while overall economic activity edged down in the first quarter, household spending and business fixed investment remained strong.
  • Notably, the Committee said that implications for the U.S. economy are highly uncertain due to the Russia-Ukraine conflict, and that together with COVID-related lockdowns in China are likely to exert upward pressure on inflation and likely weigh on economic activity. This sequence of statements seems to indicate the difficulty of ascertaining correct policy given these events.
  • In his press conference after, Fed Chairman Jerome Powell repeatedly emphasized that the Fed is committed to bringing down inflation: we’re strongly committed to restoring price stability, and that the Fed has an overarching focus to bring inflation back down to our 2% goal.
  • Immediate market reaction in Treasury yields was a slight move lower for all maturities by a few basis points, primarily in the front end of the curve which is still fully pricing almost another 200bps of rate hikes this year resulting in a terminal Fed Funds rate in December 2023 of about 3.0%. Given that the expected path of rate hikes is so steep and abrupt, cash held in money market funds may soon be paying as much as 2% by the end of August.
  • With the short-end staying contained at pre-FOMC levels, the long-end also remained flat initially. Nevertheless it has moved considerably higher since the last FOMC meeting in March.

Our takeaways

  • Our impression is that was a fairly hawkish statement by the Fed (more 50bps rate hikes this summer were all but confirmed), but one that was fully expected by the market. There were no surprises, other than perhaps Powell explicitly taking a 75bps rate hike next month off the table and not ratcheting up expectations for monetary tightening even further.
  • The Fed is communicating that is very focused on bringing down inflation, and doing so through both tools of rate hikes and QT. Our base case is that we expect Treasury yields to peak during 2022 given that they are near 10y historical peaks, likely near or below current yield levels.
  • Additionally, there is the possibility that the yield curve may invert as it did in early April should the current projected level and quantity of monetary tightening begin to severely disrupt the economy.
  • That being said, should inflation remain stubbornly elevated due to a continuation of supply-chain disruptions or new exogenous supply shocks in key goods due to geopolitical events, it is very possible that the Fed will determine that it has no choice but to continue to act even more hawkish, as Powell stated: if higher rates are required, we won’t hesitate to deliver them. In that case, Treasury yields may move somewhat higher than current yield levels as the market adds term premium.

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