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Jan 26, 2022
1:30pm: 30 Minutes to Statement Release
All eyes are on Jay Powell and the Federal reserve this afternoon as investors around the world are looking to see what bits of information they can glean from statements made regarding US monetary policy going forward. The investing mantra of “don’t fight Fed” is one that many investors (myself included) take to heart. In essence it means that you need to organize your investments to ride the ebbs and flows of monetary policy. If the fed is tightening, you need to shore up your interest rate exposure and hold onto your blue-chip stocks. If the Fed is accommodative you need to buy long bonds and look for higher growth equities.
This explains what we have seen to start the year. The Fed has signaled that they intend to raise rates as many as 4 times in 2022 and begin to unwind their balance sheet by letting bonds purchased as part of Quantitative Easing mature, or sell them back to the market. As a result, the market has shifted to “not fight the Fed” we have seen high flying Tech stocks sell off aggressively and bonds retreat as well.
It is important to remember that at this moment, the Fed has not actually made any moves. At this point we know that they are tapering their asset purchases, so in effect we are still in a very accommodative environment. We know that they are satisfied with the state of the jobs market and that they are unsatisfied with the current level of inflation. CPI has risen to 7% in year over year change. The proposed rate hikes are designed to dampen demand and economic activity and stem the tide of inflation.
So, what are we looking for today?
Taper
- What is the current speed of tapering and when will asset purchases cease?
Rate Hikes
- When is the first hike going to take place and will they telegraph a hard timeline of further hikes?
Inflation
- What is the glidepath for inflation in the mind of the Fed? How does this affect their thinking on rate hikes?
Jobs
- The Fed has signaled that they are satisfied with half of the dual mandate, however jobs data has slowed significantly (October +648k, November +249k, December +199k). Is this a topic of concern?
Balance Sheet Run Off
-When and at what rate will the Fed reduce their balance sheet? Will they be actively selling?
2:00 PM Statement Release
So, what did we get?
Taper
“The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March. Beginning in February, the Committee will increase its holdings of Treasury securities by at least $20billion per month and of agency mortgage‑backed securities by at least $10billion per month. The Federal Reserve’s ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”
TR: This is in-line with expectation. Asset purchases wrapping at the end of February. Setting the table for a March rate hike
Rate Hikes
“the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent. With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”
TR: The key term here is “soon”. This to me is a clear statement of intent for the Fed to raise rates at the cessation of asset purchases. Translation: we are cleared for lift-off. What we did not see was a plan laid out. The Fed has committed to exactly one rate hike. I think this is net dovish.
Inflation
“Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation… “
“The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, including from new variants of the virus.”
TR: I think this is the Fed putting language in that gives them options. Here they are essentially saying that inflation is being caused by supply disruptions and the coronavirus. This gives them the “backdoor” for explaining away a drop off inflation and a slowing of rate hikes towards the back half of 2022…in my opinion.
Jobs
“Job gains have been solid in recent months, and the unemployment rate has declined substantially.”
TR: Not much to see here.
Balance Sheet Run Off
TR: The Fed actually released a bonus press release here, perhaps the surprise of the day. This may be the most dovish piece. There was a great deal of anxiety that the Fed would go from purchases to outright selling of assets on their balance sheet. That’s not what we are seeing here. What this statement boils down to is: The Fed is focusing on the Fed Funds Rate as their primary tool. They will be letting bonds mature and not reinvesting interest…not actively selling. They will adjust according to economic developments.
2:30 PM : Jay Powell Speaks
Taper
- “The economy no longer needs sustained high levels of monetary policy support”
- “Both sides of the mandate are calling to move away from highly accommodative policies”
Rate Hikes
- “Making appropriate monetary policy in this environment requires humility, we need to be nimble”
Inflation
- “Expect Inflation to decline over the course of the year”
- “We will be asking all year long…are things turning out as we expect?”-“Inflation risks are still to the upside”-“We do expect that there will be relief on the supply side”
Jobs
- “Quite a bit of room to raise interest rates without threatening the labor markets”
- “The labor market is VERY, VERY strong right now”
Balance Sheet
- “Reducing our balance sheet will occur after the process of raising interest rates has begun”
- ”Primarily treasury securities”
- “The balance sheet is much larger, duration is much shorter, economy is much stronger and inflation is much higher” TR: to me this seems to lean toward moving sooner or faster…but don’t want to speculate.
Summary:
TR: My initial reaction to the pre-released Fed Statement was net dovish and well structured to give outs to Jay Powell on potential rate hikes and balance sheet run off. However, as the press conference went on, Jay Powell’s statements seemed more and more hawkish. My conclusion is that Jay Powell and the Federal Reserve are going to raise rates and are going to do so based on how inflation pans out. The Committee would not commit to a schedule or framework, but reading between the lines, the economy is in good shape and the one thing that will disrupt it is sustained high inflation. Powell wants to foster a period of sustained growth just as we had in the post Global Financial Crisis era and according to his comments would have continued thru 2020 if not for the pandemic.
Director of Fixed Income, Portfolio Manager
Tom joined the Narwhal team in the fall of 2018. He has a bachelor’s degree in Finance from Kennesaw State University. Tom has spent his career trading fixed income on both an institutional and retail level, specializing in Municipal Bonds. He holds Series 7 and Series 66 Licenses. Tom lives in Marietta with his wife, Maeve. When he’s not in the office, he enjoys playing rugby, traveling and watching Tennessee football.
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