Fed Research – Preview: 50bp rate hike

Danske Research Team Danske Bank A/S

Key takeaways

We expect the Federal Reserve to hike the target range by 50bp, a view shared by consensus and market pricing. We expect the Fed to signal that more 50bp rate hikes are likely in coming months in order to get quicker back to neutral.
We expect the Fed to announce the balance sheet runoff to start in mid-May. We expect the cap to be set at USD95bn as outlined in the minutes.
Our current Fed call is that the Fed will hike by 50bp in May, June and July and 25bp in September, November and December (a total of 225bp). We still see risks skewed towards faster rate hikes, as monetary policy remains too accommodative.
FX: At present, we forecast EUR/USD in 1.05 in 12M and we see downside risks to this estimate.
FI: We forecast that 10Y UST yields will move above 3% over the next three months. We have a 3.10% six months target.

Fed: Quickly back to neutral

Since the latest meeting in March, FOMC members have made it clear that they desire to front-load rate hikes in order to get the Fed funds target rate quickly back to neutral, as monetary policy remains too accommodative given the strong labour market and very high inflation rates. The only reason that the Fed did not hike by 50bp already in March was because of elevated geopolitical uncertainty and financial stress after the Russian invasion of Ukraine. Hence, it is widely expected that the Fed will hike by 50bp, which is fully priced in markets. St. Louis Fed President James Bullard said he would like to hike by 75bp but it does not seem like a consideration supported by the rest.

It is one of the interim meetings without updated projections (no new dots). We expect, however, that the statement and the press conference will reflect what we have heard from the Fed since the last meeting: that the Fed desires to get the policy rate quickly back to neutral.

We expect the Fed will announce that the balance sheet runoff will begin in mid-May. We expect the cap to be set at USD95bn per month as outlined in the minutes from the March meeting (USD60bn for US Treasuries, USD35bn for mortgage-backed securities). There is a lot of discussions about how much impact QT has on the real economy and some argue that it may be zero. A Fed notes paper from 2019 finds that QT of 2% of GDP corresponds to approximately 20bp rate hike. A cap of USD95bn per month corresponds to a yearly cap of USD1,140bn or nearly 5% of annual US GDP, so the current QT plan corresponds to a 50bp rate hike in a year. The calculation assumes the cap is binding, which it mostly will not be for MBS. So even if there is an impact, it is quite small in the big scheme of things. We discuss the implications of QT in more details overleaf.

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Author

Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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