Fed accelerates the tightening cycle – UOB

Senior Economist at UOB Group Alvin Liew and Rates Strategist Victor Yong review the latest FOMC event (June 15).

Key Takeaways

“The 14/15 Jun 2022 FOMC was hawkish as the Fed accelerated its rate hike cycle by lifting the policy Fed Funds Target rate (FFTR) by 75 bps to 1.50-1.75%, and it signaled clearly that ongoing rate hikes will be appropriate with its focus on reining in inflation. This was the biggest rate hike and only the second time the Fed hiked by 75 bps, since 1994. But FOMC Chair Powell’s comments in his press conference was less hawkish as he reiterated that the US economy is well-positioned to deal with higher rates and assured markets that a 75bps hike is not a “common” occurrence.”

“The other key focus was the latest Dot-plot chart which showed FOMC policymakers pivoting to an even faster pace of tightening as they now gravitate towards the view of the Fed policy rate at 3.4% by end 2022 (markedly higher from 1.9% in Mar 2022 FOMC) which implies at least three more 50 bps and one 25 bps rate hikes in the remaining 4 FOMC meetings in 2022 (i.e. Jul, Sep, Nov and Dec).”

“Reflecting the Fed’s underestimations about inflation, the headline PCE inflation forecasts were again adjusted materially higher to 5.2% for 2022 (from 4.3% in Mar FOMC). But it was growth revisions that caught the attention, as 2022 GDP growth outlook has been revised markedly lower to 1.7% (from 2.8% made in Mar FOMC) and growth will remain low at 1.7% in 2023 (from 2.2% in Mar FOMC), both below trend growth. Unemployment was also not spared in the latest report, likely reflecting the negative impact of the Fed’s accelerated rate hikes on the US labor market situation, with jobless rate exceeding 4% by 2024.”

“FOMC Outlook –  Even Higher, CPI inflation the key determinant: Powell clearly highlighted the importance of headline CPI inflation to inflation expectations (and by that extension, to Fed policy). We will mark the Jun CPI (due on 13 Jul 2022, 8:30 pm SGT) as the key determinant of whether we get a 50 bps or 75 bps hike for the next FOMC on 26/27 Jul. Currently, we are projecting US CPI inflation coming in at 0.8% m/m, 8.4% y/y in Jun (from 1% m/m, 8.6% y/y in May). Thus, inflation is still elevated and accelerating sequentially but the headline print will be off its peak (i.e. lower at 8.4% versus 8.6%), so that will warrant a 50 bps hike for July, in our view. However, if inflation accelerates more than 0.8% m/m, and prints above 8.6% y/y for Jun, then that will mean a stronger response from the Fed is required, i.e. 75 bps.”

“In addition to the move in Jul, we expect another two more 50bps rate hikes in Sep and Nov FOMC before ending the year with a 25 bps hike in Dec. Including the 150 bps of hikes to date, this implies a cumulative 325bps of increases in 2022, bringing the FFTR higher to the range of 3.25-3.50% by end of 2022, a range largely viewed as above the neutral stance (which is seen as 2.25-2.50%, the Fed’s long run projection of FFTR). We maintain our forecast for two more 25 bps rate hikes in 2023, but likely to be brought forward to the first three months of 2023, bringing our terminal FFTR to 3.75-4.00% by end 1Q-2023.”

“Rates Outlook: Overall, the message from Jun’s FOMC has not changed our cyclical market views on the yield curvature and the SG versus US yield spreads. We continue to see the upside potential being capped on both (i.e. curve steepening and SG discount narrowing) in the near term. The updated Jun Dot plot was shifted higher, and the gap between peak FF and long-term neutral FF was widened. This was in line with what we had laid out in our May Monthly FX + Rates report. On the back of our US macro team’s FF forecast update, we recalibrate out end 2022 10Y UST forecast to 3.80% and see increases in the bond yield tapering off into 2023.”