25 BPS Hike In March Seems Most Likely, Fed Passes Trading Restrictions for FOMC Members, Bank Presidents and Staff

FS Insight Team

Fed minutes were released on Wednesday and actually helped the market regain some of the losses caused by Russian aggression. They indicated, unlike the comments of Bullard, that most of the committee is still committed to a measured action, not shock and awe 50 bps hikes or hikes between meetings. The Fed has been a steady tailwind for the market since the advent, but it has also had consistent messaging.

The recent string of high inflation reports has put pressure on the Fed and is exposing an FOMC that may be losing consensus on the best course of action on inflation. JP Morgan joined Goldman in upping its projections to one rate hike every meeting, or seven separate rate hikes in 2022. Our Head Of Washington Policy, Tom Block, makes a good point that the Fed tends to not favor taking action in October of an election year. Nonetheless, the large banks continue to up expectations.

New York Fed President John Williams was one of many Fed officials to push back against Bullard and others’ suggestions of an accelerated rate hike pace, or of an initial 50 bps hike. The Governor told reports on Friday that “There’s no need to do something ‘extra’ at the beginning of the process of liftoff. We can…steadily move up interest rates and reassess. I don’t feel a need that we’d have to move really fast at the beginning.”

Many market participants have not been alive or at least active participants in markets since inflation was at similar levels 40 years ago. There are almost no portfolio managers around who were working then. Yet, inflation is one of the banes of investing particularly in fixed income markets. Those who envision a Fed more akin to the more “fire and brimstone” days of Chairman Volcker are missing some very key things that have changed since then.

For one thing, the era of de-regulation had left its mark on the Fed. The economy was far more regulated in many ways in the early and mid-twentieth century. One thing that was a key part of the Fed’s toolbox, or at least made it more potent, were the Regulation Q interest rate ceilings that were in place from 1933 to 1986. The interest rate ceiling made monetary policy a more effective, if also draconian, tool. Because rates were capped, the Fed could raise rates enough to essentially cause a purposeful credit crunch. That type of action is no longer possible, and investors greatly prefer what we’ll call the New Testament Fed.

More than the levels of interest rates themselves, or the number of hikes, part of the extreme uncertainty around the Fed is that spiraling inflation could resurrect a more kinetic Federal Reserve too busy panicking about inflation to worry about its effect on markets. Here too, many folks may not have been paying attention. The Fed is now much more involved in the promotion of financial stability, and this inherently limits how much it can tighten before blowing up credit markets.

The Fed announced new trading rules that not only band stocks, bonds, sector funds, and options but also cryptocurrencies. The bans on types of investments go beyond FOMC  members to bank presidents and even research staff. A Fed trading controversy in 2021 caused the fall of two Fed bank presidents and the early resignation of Vice Chair for Supervision Clarida. The tapering of monthly purchases of $80 bn of Treasuries and $40 bn of MBS began in November and was accelerated in December. The Fed is on track to taper down to no more asset purchases by its March meeting, but still has around $30 bn in securities to purchase. The Fed will be done with asset purchases in mid-March 2022 at this pace.  The benchmark yield on the 10-Year Yield was 1.927%

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