Fed Raises Rates to Begin Inflation Fight

In a well telegraphed move, the Federal Open Market Committee (FOMC) of the Federal Reserve raised the federal funds rate by 0.25 percent today with one dissent (St. Louis Fed President James Bullard preferred to raise the rate by 0.5 percentage point). The fed funds rate now lands in the 0.25 to 0.50 percent range. The Committee “seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.” Given that the two main variables which the committee targets for setting monetary policy (employment and inflation) are either at their respective goal (employment) or higher (inflation), markets anticipate further increases in the fed funds rate this year. In addition, as expected, the FOMC announced that its quantitative easing program has ended and will begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities “at a coming meeting.” Finally, it is important to note that the uncertainty surrounding COVID-19 and the Ukraine situation and its impact to the U.S. economy, coupled with the continued vacancies of key Federal Reserve positions, leave the future path of monetary policy cloudy, albeit very much reliant on future data.
Unsurprisingly, the FOMC “dot plot” revealed an “inflation fighting” course of action. After today’s rate decision, FOMC members see as many as six additional hikes in 2022 and four hikes in 2023. This is more hawkish than current market expectations. Similarly, Chair Jerome Powell’s press conference demonstrated that the FOMC is serious about making sure that inflation or inflation expectations do not become unhinged. Additionally, the latest summary of economic projections points to GDP growth slowing from 2.8% at end of 2022 to 2.2% for 2023.  Unemployment is expected to end 2022 at 3.5% and remain at that level for 2023. Inflation is projected to end 2022 at 4.3% and then drop to 2.7% for 2023. Clearly, the FOMC is confident that the economy can withstand tighter monetary policy. Similarly, the committee remains convinced that inflation will come down over time.  These are two questions for the markets.
Remaining meetings this year are May 3-4, June 14-15, July 26-27, September 20-21, November 1-2, and December 13-14. Future FOMC decisions at each of these meetings will be subject to the data at hand. In Chair Powell’s terms, the committee will remain “nimble” in its approach to monetary policy.
LIM portfolios generally remain in a short duration stance with overweight positions to credit sectors. While recent market activity has been volatile, economic fundamentals continue to support these positions. With the FOMC moving to a more restrictive monetary stance, it is important to be more vigilant to idiosyncratic risks within portfolios and, as in the words of Chair Powell, remain “nimble” with regard to asset allocation and security selection.
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