The Federal Reserve
avoided a shock to equities in an already weak September, but will investors remain comfortable with the hawkish tilt?
As expected from its decision yesterday, members pulled forward rate-hike expectations
on the dot plot. And Fed chief Jay Powell
telegraphed a tapering announcement at the next meeting in November. Tapering is expected to end around mid-2022 and liftoff could occur after that, although 2023 still seems the most likely timing for the start of rate hikes for now.
"What is clear is that inflation is likely to be the determining factor for liftoff and the pace of rate hikes," Deutsche Bank Chief U.S. Economist Matthew Luzzetti writes in a note. "If inflation is at or below the Fed's current forecast next year of 2.3% core PCE, liftoff is likely to come in 2023, consistent with our view. However, if inflation proves to be higher with inflation expectations continuing to rise, the first rate increase could well migrate into 2022."
Scott Ruesterholz, portfolio manager at Insight Investment, is expecting a gradual liftoff and notes the Fed "is expecting inflation to run above 2% through 2024 even as they keep rates below their neutral 2.5% estimate." "That shows how committed they are to fostering as strong of a labor market recovery as possible." But was also the discussion and debate about asset purchases and how to communicate a taper within the FOMC and the markets a waste of energy?
"All the time spent deliberating on prospective tapering, and the hours of market-participant focus on it, could be much more efficiently spent elsewhere," Rick Rieder, BlackRock CIO of Global Fixed Income writes. "We have argued for some time now that the economic conditions were ripe for a more normalized monetary policy, and that this, in fact, could mitigate the possibility for rising unintended consequences that could risk undermining the recovery that the Fed helped to engineer."
Yesterday "we learned a bit more about the extremely deliberate evolution at the Fed, which now seems to be moving similarly to some other developed market central banks (Bank of Canada, Bank of Korea and the Bank of England) to take the first steps toward normalizing policy in the wake of the pandemic," Rieder adds.
Stock rise, yield curve flattens: The broader stock market had a choppy reaction to the Fed yesterday, finishing solidly up, but well off the highs of the day. Investors look to be balancing the positives of the central bank dealing with inflation with the negatives of removing accommodation, even with rates still at zero.
Still, the S&P
(SP500) (NYSEARCA:SPY) has a chance to finish the week higher with two strong sessions. It's currently 37 points off the flatline and futures
(SPX) are up more than 0.5%. The 10-year Treasury yield
(NYSEARCA:TBT) (NASDAQ:TLT) is flat at 1.33% and the yield curve flattened yesterday, with short-term rates moving up
(NYSEARCA:SPTS) (NASDAQ:VGSH).
"So the market seems to believe the more hawkish the Fed gets the more likely they'll control inflation and/or choke the recovery," Deutsche Bank's Jim Reid says. "The puzzle is that even if the dots are correct, real fed funds should still be negative and very accommodative historically for all of the forecasting period. As such the market has a very dim view of the ability of the economy to withstand rate hikes or alternatively that the QE technicals are overpowering everything at the moment."
But Ruesterholz notes "an economy benefiting from very accommodative policy with significant excess savings," and says "markets continue to benefit from a 'wall of cash' looking to buy dips and find yield." (
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