The Daily Update - Fed rate path and destination

Its Jerome Powell’s first policy meeting as Fed Chairman; and with the near certainty that rates will be raised to 1.5-1.75% everyone is really now only interested in what the man has to say about the effects of stimulus in an already tight labour market, inflation concerns, and any sign that the Fed is playing cautious in the early days of Powell at the helm. Currently implied probabilities show around 40% expect 3 quarter-point-rises this year with the remainder evenly split between expecting more or less than 3 hikes.

As the markets wait for the inevitable from the Fed, global equities continue to trend lower and bond yields slightly higher: with 10-year Treasury yields back at the top of the 2.8%-2.9% range where they have been fluctuating this month. But regardless of the path to normalised rates, being 4 or 3 (or 2) hikes this year, much of this short term speculation should have little impact on the Longer Term Fed Funds Target Rate. Consequently the likely and apparent upper range for longer dated Treasury yields should persist, with 30-years failing on numerous occasions over the past 3 years to push beyond 3.25% level.

Watching how this long term rates projection evolves and is interpreted by markets will be a key factor to monitor in coming months. With the stellar February jobs report, there is the possibility that today’s implied longer term target rate from the committee jumps back up to the 3% level, from 2.75% currently. But this target has steadily fallen from 4% over the past 4 years; and we estimate that markets have underreacted to this gradual shift lower which effectively represents lower expectations for the equilibrious level of inflation and growth in the country. Unless this trend sharply reverses we still contend that any transient faster pace of tightening should still affect the shorter-end proportionally more than the longer-end.

Lastly, as its world poetry day we’ll sign-off with today’s limerick by @twitmericks:

There is an old fellow named Putin

With whom the UK is disputin'

But whose reelection,

With some genuflection,

Old Juncker and Trump are salutin'.

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