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Post-July 2022 FOMC Rate Hike Outlook

The US Federal Reserve raised interest rates by the much-expected 0.75% yesterday. This was in line with where the Fed Funds futures are trading prior to the meeting. Just 2 weeks ago, the market actually priced in a full percentage point hike after a record high CPI print of 9.1% which exceeded estimates. Fortunately, that got toned down after Fed member James Bullard, who has always been on the hawkish side, said he favors a 0.75% hike. He kind of sets a good "boundary" for where the Fed is headed as far as a rate hike is concerned. And these are also backed by market data which suggest inflation may be on its way to slowing down. (see a prior post and video where we talked about this)

The Market Welcomed The Hike?

The market reacted tremendously well to the hike yesterday. S&P 500 rose 2.6%. In fact, almost all asset classes went up.

Asset Class Performance on 27 July 2022
Asset Class Performance on 27 July 2022

But no, it wasn't because the market liked the hike. For one, this hike was already very much priced in. So that alone is unlikely to produce the outsized move. The more likely reason was Fed's message about slowing down future rate hikes at a certain point that gave the boost. That gels with the developing recession story market are increasingly expecting from which hikes could be stopped or even reversed. Well, at the moment, the US Fed thinks a soft landing is possible. But I wouldn't place too much emphasis on what Fed says of the future. Because they are often wrong. So, a better choice is to just watch what the market is saying.

Fed Funds Rate Hike For 2022

Fed Funds Rate Expectations Change
Fed Funds Rate Expectations Change
Expected Fed Funds Rate 2022
Expected Fed Funds Rate 2022

The expected year-end Fed Funds rate retreated to 3.5% from 3.9% just a month and a half ago. As it is now, the market is leaning toward a 0.5% hike for September and another 0.5% in total through November and December bringing the year-end rate to 3.5%.

What Is The Yield Curve Saying?

Yield Curve 2022
Yield Curve 2022

The yield curve went inverted as of 6 July 2022. As you can see, the yields 1 year and below moved up while longer yields of 2 years and above moved down. Both the 1-year and 2-year yields are now a fair bit higher than the 10-year yield. The shorter-term yields are more affected by the US Fed's rate hike. And the lower yields on the long end tell us the market expects the rates to come down in the future. And rates will come down if growth comes under threat, demand falls, and inflation eases. An inverted yield curve is a pretty reliable indicator of a recession down the road.

It may seem that things have somewhat stabilized at the moment. But if you have been around the markets long enough, you know the switch can just flip when expectations miss their mark. A lot hinges on how inflation moves in the months that follow. We need to see inflation slowing and it needs to slow fast enough else we can get ready for a rough ride again.

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