The global market has been volatile before the interest rate hike in May, can the Fed achieve a "soft landing"?

Since April, Nasdaq stocks have lost more than $2 trillion.

With only two weeks to go before the May meeting on interest rates, the Fed has entered a period of silence as usual. After the intensive speeches of several senior Fed officials, the policy tone for May has basically become clear, but some details have yet to be revealed.

Next, the performance of economic data will likely determine the intensity of policy efforts, but inflation expectations are making the prospect of a "soft landing" full of uncertainty, which has also become an important factor in recent market volatility.

The combination of raising interest rates and shrinking the table is on the line

Federal Reserve Chairman Jerome Powell said at an International Monetary Fund (IMF) forum event last week that it was appropriate to accelerate the pace of rate hikes, and that 50 basis points would be "on the table" at the next meeting.


This is also a microcosm of the position of Fed officials since April. Although St. Louis Fed President James Bullard has said that he does not rule out the possibility of a sharp 75 basis point rate hike, 50 basis points is still the current consensus within the Federal Open Market Committee (FOMC). As the last official to speak before the silence period, Cleveland Fed President Loletta Mester said the possibility of 75 basis points does not need to be considered for now, and she supports raising interest rates by 50 basis points to put inflation on a faster downward trajectory , "Let's move on to a methodical policy course and not be overly aggressive."

The hawkish rhetoric from all sides means the Fed's rate expectations will be steeper than the March forecast. Mikael Olai Milhoj, chief macro analyst at Danske Bank in Denmark, said in an interview with a reporter from China Business News that in view of the current price pressure, the Federal Reserve must accelerate the tightening of monetary policy to achieve the purpose of suppressing inflation expectations. is the key. He analyzed that the impact of monetary policy on the supply chain is relatively limited, so controlling the demand side has become the goal. "Currently, consumer demand is too high, and interest rate hikes are mainly to tighten the financial environment and moderately slow demand growth, so as to reduce inflationary pressures. ."

The U.S. consumer price index (CPI) rose 8.5% in March from a year earlier, the largest increase since 1981. The Fed's current inflation crisis has grown even more acute as the situation in Ukraine pushes up food and energy prices. Fed funds futures show that the market is actively pricing in multiple consecutive 50 basis point rate hikes by the Fed.

Milhoy warned that the U.S. labor market has tightened further in combination with recent employment data, and the risk of a potential wage-inflation spiral is heating up as wage growth is not enough to make up for rising prices. He expects the Fed to announce a rate hike of 50 basis points at its three meetings from May to July.

Regarding the details of the reduction of the balance sheet, Fed officials have not mentioned much in their recent speeches. Combined with the minutes of the March meeting, the FOMC has reached an important consensus on this issue. The initial plan is to realize the monthly cap of US$60 billion in US Treasuries and US$35 billion in agency MBS in stages. Members may discuss whether it needs to be higher than the original setting. Set baseline 3 months to reach cap target faster.

Affected by the Fed's policy expectations, the benchmark 10-year U.S. Treasury yield exceeded 2.90% last week, up more than 140 basis points during the year. The upward trend of the "asset pricing anchor" has severely suppressed risk appetite. The Nasdaq fell by more than 10% in April, and the market value has evaporated by more than 2 trillion US dollars.

Need to go beyond the neutral rate

Relative to the policy resolution in May, an important factor triggering recent market volatility is investor concerns that the policy is too aggressive.

In the March meeting minutes, many participants noted that one or more 50-basis-point rate hikes within the target range may be appropriate. Many members believe that it is appropriate to quickly change the stance of monetary policy to neutral. Some participants argued that a significant risk now is that inflation and inflation expectations could become entrenched.

Now price pressures are getting trickier. In the 1980s, then-Fed Chairman Paul Volcker stopped the inflation wave of as high as 14.5% through aggressive interest rate hikes and two recessions. This round of price increases is driven by the combination of the epidemic and the situation in Ukraine, but the 6% inflation rate that has lasted for nearly a year has made the Fed realize the seriousness of the problem. Inside the Fed, some dovish dovish members have "turned on their feet" one after another and began to call for the key interest rate to be raised to a "neutral" level by the end of the year to curb the risk of high inflation. CME Group's interest rate watch tool FedWatch shows that the market expects the Fed's federal funds rate to range from 2.75% to 3% by the end of the year, which will push the Fed's target rate beyond the "neutral" level.

From a historical perspective, this is also one of the fastest rate hike cycles by the Fed. During the cycle that began in mid-2004, it took the FOMC two years to reach a neutral rate. In the cycle starting in late 1993, it took a year to reach the neutral rate. According to current market expectations, this round will only take 9 months.

A reporter from China Business News found that at present, the Fed has not reached a consensus on whether it needs to go beyond the neutral interest rate, including Fed Governor Waller, Chicago Fed President Evans and other officials expressed support, while the incoming Fed Vice Chairman Briand , Atlanta Fed President Bostic and San Francisco Fed President Daly and others tend to make decisions based on economic data. "I think it's a prudent path to move quickly towards neutral rates by the end of the year," Daly said.

However, fears of a recession are rising. "I think the odds of us entering a recession over the next 12 months are about one in three, and that odds are continuing to rise," Moody's chief economist Mark Zandi said last week. With the sharp increase in interest rates and the shrinking of the balance sheet, it will become more difficult for the Fed to stabilize the economy, and a "soft landing" will become more difficult. Rising short- and long-term bond yields are increasing the cost of all kinds of loans -- most notably the average rate on a 30-year mortgage, typically used to buy a home, rose above 5% last week, a key channel for the Fed to influence the economy .

Goldman Sachs chief economist Jan Hatzius sees a 35 percent chance of a U.S. recession in the next two years. Achieving a so-called "soft landing" could be difficult, he wrote in the report, with 11 of 14 U.S. tightening cycles since World War II showing recessions within two years.

Article source: First Financial