Macroeconomics: Fed Minutes - Hawkish Again

• The Federal Reserve’s March meeting minutes were hawkish, adding further upward pressure to Treasury yields and the USD after Governor Brainard’s comments this week on inflation.
• Many Federal Open Market Committee members favoured 50bps rate hikes in future meetings after the FOMC agreed last month to lift the fed funds rate by 25bps to 0.25-0.50%.
• The minutes also showed the Fed will slash its balance sheet by USD95 billion a month to start unwinding its pandemic quantitative easing.
• Yesterday, we revised our Fed call and now see 50bps rate hikes in May and June followed by 25bps increases at each meeting after until fed funds hits 2.75-3.00% in March 2023.

Following Federal Reserve Governor Brainard’s remarks on inflation this week, March’s Federal Open Market Committee meeting minutes were also hawkish. 10Y Treasury yields hit three-year highs of 2.65% and the USD rallied sharply.

First, many FOMC members favoured a 50 basis point rate hike both last month when the Fed lifted fed funds 25bps to 0.25-0.50% and at future meetings. The minutes noted that: ‘…many participants noted that - with inflation well above the Committee’s objective, inflationary risks to the upside, and the federal funds rate well below participants’ estimates of its longer-run level - they would have preferred a 50-basis point increase in the target range for the federal funds rate at this meeting.’

In addition, the minutes showed: “…. many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified.”

Second, officials were keen to raise the fed funds rate, so that it quickly returns to neutral levels around 2.50% and, if necessary, above that to curb inflation: “participants judged that it would be appropriate to move the stance of monetary policy toward a neutral posture expeditiously. They also noted that, depending on economic and financial developments, a move to a tighter policy stance could be warranted.”

Third, the meeting minutes outlined plans for the Fed to start slashing its balance sheet to tighten financial conditions and thus also curb inflation.

Source: Bank of Singapore, Bloomberg.

The chart shows the Fed’s and the European Central Bank’s balance sheets soared during the pandemic through quantitative easing (QE) bond purchases. The Fed’s rose from USD4 trillion to USD9 trillion. But now with US inflation near 8%, March’s meeting minutes signalled the Fed, from as early as May, will start rapidly cutting its balance sheet. By capping the reinvestment of its maturing bond holdings over an initial three- month period, the Fed intends to cut its balance sheet consistently by USD95 billion a month. Thus, its quantitative tightening (QT) will result in its bond holdings falling by over USD1 trillion a year.

Following Governor Brainard’s hawkish comments, we revised our Fed call yesterday and now see 50bps rate hikes in May and June followed by 25bps increases at each meeting after until fed funds hits 2.75-3.00% in March 2023.

March’s minutes underscore our views that:

• the USD will stay in demand in the near term.
• US yields will rise further with our new 12-month forecast for 10Y Treasuries at 2.95%.
• yield curves are likely to invert for the next 6 months as the Fed shifts to 50bps rate hikes.
• higher yields will keep testing risk assets, but we don’t expect the US economy to suffer a recession this year given reopening tailwinds.
• and, yield curves should become positively sloped again after 6 months’ time as QT results in the Fed shedding more 10Y and 30Y bonds, putting renewed upward pressure on long-term yields versus short-term 2Y yields.

This article was first published by Bank of Singapore on April 7, 2022. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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