Will The Fed Hike Sooner Than Expected?

The U.S. Fed is caught in a difficult place that will require tremendous communication efforts for the market to understand. So far down the road during the pandemic, the Fed came to the rescue. It eased monetary conditions and also urged Congress to deliver fiscal stimulus. 

Its words were heard, and the Fed’s actions eased the world’s desperate need for dollars seen in the spring of 2020. Fast forward to March 2021; the Fed is in a tough spot.

On the one hand, with every stock market decline, the market participants expect the Fed to intervene. However, the stock market is still close to all-time highs, and it is unlikely that the Fed will keep intervening verbally, especially because easing is still ongoing and about to increase.

On the other hand, the market starts pricing in a stronger economic recovery. Such a recovery should bring tightening from the Fed, and the market already implies that we will see the first-rate hike in 2022. More precisely, the market priced in over 80% odds for a twenty-five basis points rate hike in 2022.

Forward-Looking Markets Pressuring the Fed

On the same note as in the previous paragraph, the same market prices in another two rate hikes in 2023 and, by the end of 2025, a tightening of monetary conditions of over 125 basis points. This translates into the federal funds rate rising from close to zero currently to 1.25% three years from now.

The problem comes from the current conditions. The markets tend to have a forward-looking attitude, and the pricing of assets in the present is based on such an attitude. Because of that, the current monetary conditions appear inappropriate, and the Fed will have a hard time explaining why.

For example, the fiscal easing will continue. The months ahead will bring a renewed round of fiscal stimulus, as $1.9 trillion in fiscal aid is about to be unleashed. This is easing, but at the same time, the money will further fuel the economic recovery, and, in turn, more jobs will be created, and so on.

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Disclaimer: None of the content in this article should be viewed as investment advice or a recommendation to buy or sell. Past performance/statistics may not necessarily reflect future ...

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