Fed Satisfies Markets, But for How Long?

US Federal Reserve Hikes Federal Funds Rate to 1.75%

Wednesday 16th June 2022 saw the US Federal Reserve decide to raise its federal funds rate by 0.75% to 1.75%. The decision was unanimous. Until last Friday, most analysts had been expecting a hike of 0.50%, but the surprising increase in annualized US CPI (inflation) released last Friday shifted expectations somewhat to a point where most financial institutions were expecting a 0.75% hike.

US Federal Reserve Dot Plot and Economic Projections

In addition to the decision on interest rates, the Fed also released its economic projections, which currently take on a special importance given the centrality of the fight against historically high levels of inflation to monetary policy.

The Fed sees the annualized US CPI rate falling sharply to 3.4% by the end of 2022, and back down to approximately 2% (the official target) by the end of 2023. This would require a fall as sharp as the recent rise has been.

The Fed was also quite optimistic on its projection concerning unemployment, which it sees rising from the current 3.6 to approximately 4.1% by the end of 2023.

The Feds statement showed that its consensus expectation sees these goals as being achieved by a monetary policy which will continue hiking until the federal funds rate reaches 3.4% by the end of the year. This implies there will be a further 1.65% of rate hikes over the remainder of 2022.

Market Impact

More than 12 hours following the data releases, the following price changes are observed in key market barometers:

• US Dollar Index +0.08%

• US 10-Year Treasury Yield -0.81%

• US 2-Year Treasury Yield -1.38%

• S&P 500 Index -1.35%

These initial market reactions are not notably large, but it is significant that we saw a small risk-on rally following the release, which has now fully reversed, except concerning treasury yields.

The big question is whether the Fed is convincing the market. Judging by the implied 2-year treasury yield, which stands close to the 3.4% seen by the Fed for the end of 2022, the market believes the Fed will stick to its declared path and overall quantity of rate hikes. Yet it seems clear that the market does not see the Feds plans as enough to improve risk outlook for the foreseeable future.

What Does This Mean for Traders？

The Feds rate hike and release seems to have produced a minor, transient risk rally against the dominant long-term risk-off trend.

It looks like this is a “buy the dip” moment, and the Fed has not produced anything of significance likely to produce a major market reversal.

The firm long-term trends in the market include long US Dollar, short US stocks, and long US yields.