A major focus point for investors this week is the two-day Federal Reserve policy meeting, with markets expecting the central bank to press ahead with a sharp rate hike and formally announce the launch of a much-anticipated balance sheet runoff.
The Federal Open Market Committee (FOMC) is
scheduled to meet on May 3–4, with remarks by Fed officials suggesting that the central bank is looking to take aggressive measures in a bid to relieve surging inflationary pressures.
The Fed’s key inflation gauge, the so-called core PCE price index that the central bank relies on heavily in calibrating monetary policy,
rose at an annual pace of 5.2 percent in March. That’s over twice as high as the Fed’s inflation target of around 2 percent.
Analysts at ING said in a recent note that they don’t expect the core PCE inflation measure to drop below 4 percent this year.
“Even if supply chains improve and we see geopolitical tensions ease a little, we doubt this inflation measure will be below 4 percent before early next year,”
they wrote, adding that elevated inflationary pressures are “certain to keep the Fed minded to tighten monetary policy swiftly” in the coming months.
Expectations for policy tightening have been reinforced by Fed officials’ recent hawkish remarks.
Fed chair Jerome Powell
said in April that the central bank is “really committed” to bringing inflation back down to around 2 percent, arguing that it’s “appropriate in my view to be moving a little more quickly” along the path of tightening monetary settings.
“I also think there is something in the idea of front-end loading … that points to the direction of 50 basis points being on the table” when the FOMC meets this week to vote on interest rates.
Traders have basically fully priced in a 50-basis point rate hike, with Fed funds futures
contracts showing a 99 percent chance for a 0.5 percent rise, which would bring the target rate to between 0.75–1.00 percent.
Brian Gilmartin, a portfolio manager at Trinity Asset Management, said in
an analysis for Seeking Alpha that the “only debate” among traders seems to be whether the Fed tightens monetary settings by raising rates by 0.5 percentage points or whether the 50-basis point hike will be accompanied by a “heavy dose” of quantitative tightening, or reducing asset buys.
High inflation has led Fed officials to reinforce market expectations for an imminent commencement of quantitative tightening and that, when it does begin, would proceed at a faster pace than the prior period of balance sheet reduction.
“All participants agreed that elevated inflation and tight labor market conditions warranted commencement of balance sheet runoff at a coming meeting, with a faster pace of decline in securities holdings than over the 2017–19 period,”
read the minutes from the FOMC’s most recent meeting in March.
Stagflationary concerns were fanned with the recent release of U.S. economic growth data, which showed GDP falling by 1.4 percent in annualized terms in the first quarter of this year.
Analysts generally expect a rebound in GDP in the second quarter, with many predicting that the lackluster first-quarter economic growth figures are unlikely to spur the Fed into a slower path of policy normalization.
“We are looking for 2Q annualized growth to come in at 2.0–2.5 percent and with inflation pressures remaining elevated and the labor market looking so tight, today’s disappointing GDP outcome shouldn’t alter the outlook for a 50bp [basis point] Federal Reserve interest rate increase next week,” ING analysts wrote.
In a
separate note, ING analysts said they expect the Fed to announce on Wednesday that it will embark on a path of quantitative tightening at a pace of $50 billion each month, rising to $95 billion by September.
