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3 Takeaways from Fed Meeting

In its recent meeting, the Federal Open Market Committee largely stayed the course with unprecedented accommodation, but offered some hawkish signals about increasing interest rates faster than expected. Our director of short duration fixed income, Peter Yi, examines three key takeaways from the meeting.

  • Rate Hike Forecast Moved Up a Year
  • They’re Really Talking About Tapering
  • A New Floor Under Near-Zero Money Market Yields
  • What This Means for Interest Rates Now

Transcript

[MUSIC PLAYING] The Federal Open Market Committee last week largely stayed the course with unprecedented accommodation, but offered some hawkish signals about increasing interest rates faster than expected. Let's examine the three takeaways from the meeting.

The committee members meet in forecast for the Fed's first rate hike shifted forward a year to 2023. 13 of 18 members expect the first rate increase to occur in 2023. While investors had already started pricing in the first hike in 2023, prior to the revised projections, the new Fed forecast now suggests two rate hikes near the end of 2023. Yet, Chairman Jerome Powell downplayed the possibility of higher rates in the immediate future and reinforced a very slow and gradual removal of monetary accommodation.

Powell, for the first time, formally acknowledged Fed discussions surrounding a tapering of its $120 billion a month bond purchasing program designed to keep rates low. However, we believe the Fed will hold off on reducing purchases until unemployment falls meaningfully and inflation stays persistently above 2%, which appears unlikely in the near term. When looking at inflation, the Fed will consider the low price comparisons from last year's shut down economy and this year's massive government stimulus.

The Fed increased by 5 basis points the interest the Fed pays on its reverse repo facility for investors in excess reserves for banks. We view this adjustment as the tide that lifts all money market boats, moving treasury bills and overnight repurchase agreements further away from negative or zero yields. Investors welcomed this new floor on short-term rates to avoid the complications of negative yields in money markets and to help alleviate the overwhelming mismatch between supply and demand of high-quality securities.

The Fed cautiously recognizes stronger growth and higher inflation. However, the Fed remains on guard about increasing rates, concerned that last year's pandemic and massive government aid is producing a temporary mirage of economic strength. Despite the more hawkish message, we maintain our 10 year treasury yield forecast in the range of 1.25% to 1.75%, with the central tendency at 1 and 1/2%.

Peter Yi, CFA

Director, Short Duration Fixed Income and Head of Taxable Credit Research
Peter Yi is director of short duration fixed income and head of taxable credit research for Northern Trust Asset Management.