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Market Update

FOMC leans more hawkish, but market reaction muted

Date:
December 20, 2021
  • kevin jones headshot

    Authors

    Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA

Summary

A more hawkish FOMC meeting, which suggested faster tapering, more rate hikes in 2022-2023, and higher inflation predictions, was in line with market expectations. Thus, reaction in rates and currency markets was largely muted, with rates curves largely holding their pre-FOMC shape.

December FOMC meeting details

Between the Fed’s prior meeting in November and last week’s FOMC, the Fed had already clued the market into a more hawkish tone, via regional Fed speeches or Jerome Powell’s testimonies to Congress. Thus, markets had priced in the expectation of a faster taper and steeper Fed dot plot, both of which came to fruition. On the taper, while the Fed had previously announced a $15 billion per month reduction in purchases of Treasury and mortgage-backed securities, it announced a doubling of that pace at its December meeting; the $30 billion reduction per month signals that tapering will conclude in March rather than June. Notably, the Fed has stated that it would not hike short-term rates before concluding tapering, so the stage for rate hikes is potentially set for the spring.

On rate hikes, while the Fed unanimously voted to keep short-term rates unchanged for the current period, the Fed’s closely watched ”Dot plot” revealed that a preponderance of Fed policymakers expected three rate hikes in 2022. An additional two hikes each in 2023 and 2024 shown in the dot plot suggest a Federal Funds rate target of 2.125% by the end of 2024. The Fed Funds rate has not been that high since early 2019.

Other notable commentary from the Fed included an assertion that the labor market still has room to improve, highlighting the low labor force participation rate relative to pre-pandemic levels. For many inflation watchers, the absence of the term ‘transitory’ with respect to inflation in the Fed statement confirms both market and public sentiment of inflation seeming persistent. Finally, the Fed also acknowledged the potential negative economic impact of new virus variants, all of which complicate the Fed’s dual mandate of facilitating a stable price environment while fostering maximum employment.

Rates markets stay the course

Because in many ways the FOMC came out as expected, rates markets didn’t move significantly; indeed, equities rallied post-Fed as investors apparently were relieved the Fed was somewhat less hawkish than expected. At 1.40%, the U.S. 10-year Treasury continues to lag levels seen earlier this year, evidently weighed down by the uncertainty surrounding inflation and the ongoing economic recovery. The middle of the curve also has flattened considerably, representing similar concerns post-omicron.

Meanwhile, short-term rates remain at their highest levels since pre-pandemic, representing the expectation of Fed rate hikes. However, as noted in the chart above, the current Libor forward curve does not reach as high as the 2.125% level exhibited in the Fed dot plot; while the market has underestimated the magnitude of Fed rate hikes during prior tightening cycles, this could be a case of history repeating itself if indeed the Fed follows through. For companies looking to take interest rate risk off the table, such a dynamic can suggest an opportune time to hedge.

(Related insight: Read, "Hedging future fixed-rate debt")

Other developments

Currency and commodity markets didn’t move dramatically following the FOMC meeting. However, across the pond, the Bank of England surprised the market with a 0.25% rate hike, a move that was only priced in with a 30% probability in GBP rates markets. This move led to a roughly 100 pip jump in the GBP-USD exchange rate to ~1.336, a move that is in contrast to the general dollar strengthening trend that dominated 2021.

(Related insight: Watch the on-demand webinar, "Treasury 2022: Opportunities, Priorities, and Trends")

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About the author

  • Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA

    Kevin Jones serves Chatham’s corporate clients in interest rate and foreign currency hedging advisory. Kevin’s expertise spans risk quantification and analysis, hedging strategy development, market dynamics, and trade execution.

Disclaimers

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