The Fed’s thorough rethink on rate hike? Don’t bet on it.

2023-05-10
Summary:

SVB failure is still reverberate across global markets as a big wake-up call for policymakers that have been taking a hard line on inflation.

SVB failure is still reverberate across global markets as a big wake-up call for policymakers that have been taking a hard line on inflation. Some argue it is now necessary to put a brake in light of the second largest bank collapse since 2008.


Bond yields plummet on Monday. 2-year US treasury yield saw its biggest daily drop since 1987 and its comparable Bund yield hit a low of 2.4% from 14-year high of 3.3% last week.


The rush into bonds came as surprise against a backdrop of soaring consumer price. Even so, the event might not deter another rate hike of a quarter point later this month, according to a CME estimate.


Extraordinary measures have been rolled out to shore up confidence in the financial system, introducing a new backstop for banks to protect the entire nation’s deposits.


Inflation fight far from over

Apparently Wall Street do not buy it while investors are seemingly overacting to what is yet to be defined a crisis.


Citigroup economist Andrew Hollenhorst said a pivot will be unlikely as the Fed sought to burnish its credentials as an inflation fighter. It expects the Fed to continue to raise benchmark fund rates to a target range of 5.5% - 5.75%.


The view is echoed by DoubleLine Capital CEO Jeffrey Gundlach who believes ‘the Fed is not going to go 50 … say 25.’


Goldman Sachs reiterated the terminal expectation o 5.25% - 5.5% although the bank now predicts the Fed will sit on its hands in the short term.


“In light of the stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its next meeting on March 22,” Goldman economist Jan Hatzius said in a Sunday note.


Bank of America chief U.S. economist Michael Gapen suggested the tightening would proceed unhampered ‘if the Fed is successful at corralling the recent market volatility and ring-fencing the traditional banking sector.’


“It would have to be a lot softer to take the hike out. By stopping here, it exposes them to risk of inflation expectations reaccelerating,” said Tom The Simons, money market economist at Jefferies.


Next week’s meeting is a crucial one in that the FOMC will update its projections for the future, including its outlook for GDP, unemployment and inflation.


CPI in focus

The February CPI report was released amid market turmoil, which complicate the path for the Fed going forward.


The index increased by 6.0% YoY, down from 6.4% in January, showing consumer prices are still running at a high pace.


‘This is an inflation update that, taken as a sole input, would suggest that a 25 (basis point) hike next week is a foregone conclusion,’ said Ian Lyngen, head of US rates strategy at BMO Capital Markets.


Housing-related costs, up 8.1% YoY, contribute to around 70% of the increase in headline inflation.


Shelter prices always lag behind real-time data by several months, so stubbornly high rents might have eased.


Service prices pick up overall with transportation costs climbing by 14.6% YoY. This could force the Fed to press ahead with its rate hike campaign.


The January report was hotter than expected, part of the reason for that Powell said last week bigger rate hikes could be in the cards.

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