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May 2022 Post-FOMC Interest Rate Update

The US Fed hiked 0.5% on its 3-4 May FOMC and will start trimming its balance sheet on 1 June 2022. This is very much in line with what the market expects and what Fed engineered it to be. Prior to the meeting, they had been upping the ante on rate hikes through all their scheduled talks. The message was clear. Fed wanted to move faster and 0.5% was on the table. There was no explicit language to rule out even faster hikes then. Anyway, I don't think Fed would want to box themselves up.

But based on what the market priced in prior to this FOMC, it is probably getting ahead of what Fed had in mind at this moment. The market had priced in a fairly good chance of a 0.75% hike for at least the next 2 meetings. That got swept down after Jerome Powell says they are "not actively considering" 0.75% hikes in the near term. All key asset classes that had been pummelled under the pressure of rapidly rising rates, be it stocks, bonds, gold, or commodities, rallied after that.

Asset Price Move on 4 May 2022
Asset Price Move on 4 May 2022

That provided a much-needed respite for many after seeing a sea of red since the start of the year. And where are we in terms of future rate hike expectations?

Fed Funds Rate Expectations (4 May 2022)
Fed Funds Rate Expectations (4 May 2022)

The expected future fed funds rates, unsurprisingly, dropped significantly after the FOMC. But the readings are somewhat baffling. Because the market is now leaning towards a 0.25% hike for most of the remaining meetings this year. We are looking at a 0.25% hike for June, thereafter a 0.5% for July, and likely 0.25% for the remaining 3 FOMCs till year-end. And just a day ago, we are even considering 0.75% hikes. It seemed that the market had just swung from being overly pessimistic to overly optimistic.

Personally, I think that is a bit overdone. To slow Fed down from what they indicated, inflation will have to show signs of abating or the recession risk builds up with slowing consumer and business spending, a weakening labor market, etc. And "not actively" considering 0.75% hikes also does not mean it is totally off the table. But of course, the expectations are changing even as I am typing now. The market takes time to digest the new information from the US Fed and it may yet reflect a different expectation in time to come. We will get more color when the FOMC minutes are released 3 weeks later.

Lastly, the yields across the different maturities all moved down in tune with the shift towards a less aggressive rate hike cycle than previously priced in. The long-term yields continue to steepen as the 1Y and 2Y yield moves down more than the 10Y.

US Treasury Yield Curve (4 May 2022)
US Treasury Yield Curve (4 May 2022)

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