Market Wire - Fed Executes 'Hawkish Pivot', Markets Unsurprised

Karl Schamotta - Chief Market Strategist

The Federal Reserve signalled an earlier and more aggressive pace of rate hikes this afternoon while announcing a second reduction in its pandemic-era asset purchase programme - executing a long-expected ‘hawkish pivot’ as it battles persistently high inflation levels. 

Tapering expectations were met: After its two-day meeting, the Federal Open Market Committee voted to keep benchmark interest rates in a target range between zero and 0.25 percent, and indicated that the central bank would cut its monthly Treasury purchases by $20 billion and its mortgage-backed securities by $10 billion - a pace that would put it on track to end the program early in the new year. 

Rate forecasts climbed: For the first time, the “dot plot” summary of economic projections showed policymakers now expect to raise rates three times in 2022, with another three moves coming in 2023 - something that has been priced into markets for months, but hadn’t previously been confirmed by officials. 

Inflation expectations leapt upward: The word “transitory” was removed from the official statement, and a new sentence: “Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation,” was inserted. In the economic projections, committee members now see the core personal consumption expenditures index - the central bank’s preferred inflation measure - topping 2.7 percent next year, and remaining elevated for the following two years. 

The employment outlook was more dovish: The statement said: “the Committee expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment” - suggesting that policymakers are not yet satisfied with progress on the second of the Fed’s two mandates. 

Omicron risks were downplayed: The statement noted that “risks to the economic outlook remain, including from new variants of the virus”, but “Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation”. 

Optionality was preserved: Officials acknowledged making “substantial further progress” toward the central bank’s goals, but noted that they remain “prepared to adjust the pace of purchases if warranted by changes in the economic outlook” - a caveat that could enable both upward or downward adjustments in monthly buying volumes. 

The greenback whipsawed: The trade-weighted dollar moved sharply higher on the release, but has since round tripped, suggesting that the central bank’s new projections have aligned it more closely with markets - but have not materially shifted longer term rate expectations. The yield curve is flattening as front-end rates climb more than longer-duration instruments. Equities are rallying, while risk-sensitive currencies like the Canadian dollar are catching a bid.  ​​​​​​