Rates' projected path looms large Rates' projected path looms large http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\path-forest-small.jpg October 20 2022 March 1 2022

Rates' projected path looms large

The FOMC 'dot plot' will be as important as an actual hike.

Published March 1 2022
My Content

The human toll and widespread destruction of a military conflict rightly makes finance a secondary concern. But the economic implications of the Russian invasion of Ukraine are far-reaching.

While the impact on the U.S. does not figure to be severe, the crisis will almost certainly slow the eurozone’s recovery and sanctions might cripple Russia’s. These will unfold on a longer timeline, but the crisis surely will affect upcoming decisions of central banks (it already has for Russia's). It’s a stark reminder that monetary policy doesn’t exist in a vacuum. Economists and pundits can debate academic issues such as the role of the Phillips Curve on Federal Reserve thinking, but the real world puts theories in their place on a weekly basis. Actually, in this case, it may have made the Fed’s job easier.

The issue, of course, is the magnitude of the Fed’s response to inflation. On the strength of January data at multi-decade highs (core CPI at 6%, its highest level in nearly 40 years; core PCE at 5.2%, a 39-year high), the markets have been expecting a 50 basis-point hike of the fed funds target range at the FOMC meeting ending March 16. We were skeptical of that, and now it seems highly likely the Fed will announce a quarter-point hike instead. Even as the conflict and international sanctions threaten to push energy prices higher, officials surely realize they must not add to the risk and uncertainty by increasing rates sharply. At the meeting, they will have the means to signal their path of normalization with the release of the Summary of Economic Projections and the dot plot. The latter approximates policymakers' views on the appropriate number and timing of rate hikes in the near future. If they are relatively in agreement, it would provide needed stability.

The credibility of that tacit communication would be helped if the Fed Board of Governors was at full strength. Partisan politics have stalled the addition of three new members. It’s frankly embarrassing that a help-wanted sign has been hanging on its Washington headquarters for many months, as if the Fed is facing the same shortage as struggling small businesses. Opposition to Sarah Bloom Raskin is futile, with the Democratic majority in the Senate. Lawmakers need to confirm them without delay. Even if they arrive in time for the FOMC meeting with different opinions, Chair Jerome Powell’s influence should be potent enough to galvanize the voters. Look for no dissent in a decision that balances a more dovish 25 basis-point hike with a more aggressive projected course of hikes this and next year.

What are the implications for the money markets? In the near term, the flight to quality has pushed front-end Treasury yields down from overnight trading out to 1-month bills, and the yield curve up to one year has flattened. But this trend should reverse when the crisis in Ukraine cools. While liquidity products are structured to benefit from rising rates, a slower approach is preferable as it typically allows yields to anticipate hikes. A short and nimble approach makes the best sense, reflected in our maintaining the weighted average maturities of our government money market funds in a target range of 25-35 days and our prime and tax-free money funds to 30-40 days.

Tags Monetary Policy . Ukraine Crisis . Liquidity .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The Personal Consumption Expenditure Index: A measure of consumer inflation at the retail level that takes into account changes in consumption patterns due to price changes.

Phillips curve: An economic model that portrays an inverse relationship between the level of unemployment and inflation on an historical basis but has come under doubt in recent decades. 

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