FOMC’s policy shifts for 2022: Next up for markets, investors
By Andrew Knoll
The US Federal Reserve’s Federal Open Market Committee announced the first interest rate hike in the US since 2018 on Wednesday, moving toward projected increases at the same 0.25% interval in each of the remaining six meetings this year.
At a news conference following the conclusion of its two-day meeting on Wednesday, Chairman Jerome Powell cited four-decade highs in inflation and a tight labour market in the committee’s rationale for its first increase in nearly four years.
The Covid-19 outbreak and Russia’s invasion of Ukraine have been contributing factors to volatility across markets and sectors. Powell also acknowledged the influence and instability that the conflict could produce.
Importantly, Powell signalled more bumps to come, stating that the committee “anticipates that ongoing increases in the target range for the federal funds rate will be appropriate”.
The vote for a 0.25% bump was nearly unanimous, with one vote favouring a larger 0.5% hike. Emphasising the need for price stability, Powell remained open to larger incremental increases in the future. The decidedly hawkish tone of the Fed was in sharp contrast to the division on rate hikes and the timing thereof just six months ago.
Markets reacted and analysts weighed in as well, as investors in equities, commodities, forex and other sectors were all impacted by the overarching policy shift by the Fed.
Capital.com synthesises a multitude of perspectives and prospective strategies for investors as the economic landscape continues adapting to the strain of a pandemic and military conflict in Europe.
While hikes were expected, the number of increases and the pace of inflation both demonstrated considerable upward movement well ahead of December’s estimates, which called for three 0.25% hikes this year and five more over the next two.
The number of likely 2022 increases, seven, now approaches the eight that had been projected for the next three years. The Fed released its summary of economic projections Wednesday, and it contained some disconcerting updates.
Significantly, gross domestic product (GDP) growth estimates were adjusted downward from an expectation of 4% in December to 2.8%. Compounding matters, the personal consumption index, a monthly inflation marker that measures what Americans pay for goods and services, was also extrapolated to be rising faster than anticipated.
Personal consumption expenditures (PCE) pushed from 2.6% to 4.3%. Core PCE, which excludes food and energy costs, jumped from a 2.7% estimate to a 4.1%
The pressure from both sides – slowing GDP growth and accelerating inflation – impacted interest rates and the pace of quantitative tightening, which some analysts anticipated would begin in June.
The Fed’s interest rate has a consensus expectation to settle at 1.9% by year’s end, signifying an additional 150 basis points across six more hikes, an entire 100bps above December projections. Rates for 2023 appear headed toward a consensus estimate of 2.8%.
Equities, bonds, forex and commodities
While measures taken by the Fed could generally be received as positive steps toward corralling inflation and equities markets reacted positively – both the S&P 500 and Nasdaq composite surged Wednesday – bond markets offered a mixed reaction.
That may indicate that investors still have some level of uncertainty regarding the timing and efficacy of the policy changes. Still, marquee numbers rose. Two-year treasury bond yields lept, as they have on each of the past six FOMC meeting dates. Ten-year yields rose more modestly but to their highest level since 2019, and haven’t dropped on the occasion of an FOMC meeting in over a year.
Deutsche Bank head of FX strategy Alan Ruskin largely pegged the performance of bonds as well as the relatively stable performance of currencies and commodities. The most active risers of late, fuelled by supply concerns and safe-haven investment strategies, were negligibly affected.
The US dollar index (DXY) fell, rose and ultimately settled at a slight loss. Gold rose marginally on the day. Natural gas, heating oil and WTI crude, which have been increasing as the clash in Ukraine disrupts supply lines, also were up very slightly. The conflict in Ukraine and its path toward diplomacy or escalation cast a shadow over many if not all policy considerations implemented Wednesday, and currency implications were no exception.
“While technically, this kind of messaging is USD positive, the impact is prone to be quickly usurped by war events,” Ruskin wrote. “A shift to a ceasefire and presumably EUR/USD jumps to close to 1.11/1.12.
“A breakdown of talks, and we head back to 1.07/1.08. The Fed in these unusual times is very much playing background to the war, but the more there are signs that Dudley’s thinking on the terminal rate is actually mainstream within the Fed, the more recent USD gains will be seen to have a solid rates underpinning, constraining some of the impact if the war turns less USD positive.”
Conflict and its strategy implications
Wedbush analyst Daniel Ives, who monitors the tech sector closely, said that he felt that in the equities market the time was ripe to pounce on tech stocks that had become as oversold as Wedbush had seen in the past five years. Software, cyber security and over-arching giants like Apple were on his to-buy.
"We strongly believe this is a bright green light to own oversold tech stocks as the market was fearing the worst from Powell & Co. and now ultimately the Fed "ripped the band-aid" off for the world to see with the liftoff now under way," Ives wrote. "While there could be major volatility going forward, we believe the tech bottom is now likely in for the year."
Jim Reid, DB’s head of global fundamental credit strategy, weighed in on the day’s events as well. While he had expected plans for quantitative tightening to be revealed Wednesday, Powell said only that they would be covered in a future meeting.
Reid also pointed out the domineering position of the Ukraine conflict, suggesting that investors continue to closely monitor the situation, which was agitated potentially by another round of EU sanctions on Tuesday.
“However, risk sentiment was buoyed later in the New York session (Tuesday) when a senior aide to (Ukrainian) President Zelenskyy noted that Russia had softened their negotiation stance," Reid wrote.
Meanwhile, the Fed has made an effort to regain a higher level of market control and shift dialogue back to less variable, less volatile drivers.
“The Fed will be attempting to wrestle the narrative back from geopolitics, which has been and will likely be the predominant market story for a time,” Reid added.