Federal Reserve:Meetings/2023 February 01

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Meeting Expectations

Market Expectations

• Market is expecting 0.25 bps with a 99% probability.

The loosening financial conditions lately could be of concern for the FED since their target is still lower inflation, analysts expect the FED to have to be careful with the words used in the conference call, as they could create a massive reaction from the market.

Analyst commentary

1. Mohamed A. El-Erian argues the Fed should raise rates by 0.50 bps. His main arguments are:

• While inflation will indeed continue to come down in the immediate future, its main drivers have been shifting to the service sector, thereby increasing the risk of more embedded price pressures when the labor market remains solid.
• With global growth surprising on the upside, the window for more orderly rate increases has been opened wider.
• Financial conditions have loosened significantly in recent months and, by some measures, are around levels that prevailed last March when the Fed initiated this hiking cycle.
• A faster journey to the peak rate that has already been signaled, and reiterated by Fed officials several times, reduces the complexities of linking the path to a variable destination.

Comment Moritz: Good Bloomberg Opinion piece by El-Erian. I tend to agree with his opinion esp. on sending a determined signal and restoring credibility.

2.Danielle DiMartino Booth, still expects 0.25bps despite financial conditions loosening:

• 0.25 bps rate hikes still expected in march and probably 1 last one in May.

• QT will still be going at the same pace, and no pause is expected. Which means tightening will still be in place in some extent.

• Treasury have been spending its TGA account due to the debt limit, adding liquidity to the markets in the short term.

Comment Moritz: I have to say that i am agreeing with the interviewer on this one. DiMartino Booth sometimes sounds very dramatic e.g. on her last sentence "and now we have rising unemployment" while the job market held up extremely well. (too well)

3. Jeremy Siegel argues Fed needs to do 25-basis-point hikes because 50 would be a disaster:

• There was so much bearish sentiment, every piece of good news will create the rally we are experiencing

• Markets hope the FED will give the message they are close the end, if they said more work to do still, markets will not react well.
• Worst yield curve inversion in 40 years, FED should not target to create an even worst inversion.

• Money supply growth at low levels not seen since great depressions that should be enough
• In the 1970s inflation money supply was increased that caused inflation (Min 2:25)
• Argues that "real" inflation when calculating with current housing data (not with housing data of the last months) is negative. (2:40)

Comment Moritz: I've added two arguments he brought up. Obvs. they are interesting topics to study. (Low Prio) Overall he appears to be too market focused for my liking. Imo it does not matter if current housing data is deflationary as there is still a problem in service inflation that consists.

Meeting Results

The FED decided to do a rate hike of 0.25 bps, to raise the target range for the federal funds rate to 4.5% to 4.75%. The market reacted positively to the release, due to hopes that inflation is coming down and the FED rate hike cycle is near the end.

Notes:

• They consider they need to remain restrictive for some time,  2 more rate hikes could be appropriate for now.

• Financial conditions over the long term is their focus, not short term movements.

• Rate cuts in 2023 are not in plans with current data

• Disinflation has been on the goods sector in current data, and housing inflation expected to slow in second half of 2023.

• Services ex housing is still not seeing disinflation, which means more job need to be done. Need better labor market balance to achieve it.

• Going forward rate hikes will be data dependent.

• Across yield curve, real rates are now positive which is restrictive. Still considering how restrictive is enough.

• Powell considers path to soft landing is possible. That is their base case.