Fed hikes 25 basis points as expected
The Fed is forecasting one 25 basis point hike per meeting this year.
Writing to you from the road today! I brought my family to Mexico for spring break—my USC Marshall students are enjoying a week off, so I’m taking advantage. Let’s dive right in to the Fed’s actions. At the end of the post, I get into some predictions for the Fed, rates, QE, and bitcoin.
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The Fed hiked rates by 25 basis points today as expected by the markets. Curiously, I was still seeing casual observers think as late as this morning that the Fed wouldn’t do anything. In fairness, the Fed has a horrible track record when it comes to its own policy rate, but we will save the critiques for later this year or in 2023 when it is forced to reverse course.
With inflation raging, the Fed has no choice here—it must hike rates to demonstrate that its eyes are open. However, recessionary indicators creep below the surface, making any tightening of monetary policy dangerous.
Loyal readers know I have been writing about the yield curve flattening we’ve undergone over the past many months. The flattening is a signal of policy error—hiking short-term rates while witnessing and even potentially causing long-term inflation and growth expectations to come down. Today, the 2s10s curve flattened to 25 bps. In December, my holiday chart pack marked this curve at 75 bps.
There are two major takeaways from a curve still modestly positive and flattening. First, the fact that the 2s10s curve is still positive and not yet inverted means the Fed has NOT run out of room to hike. (If the 10-year yield traded below the 2-year yield today, you wouldn’t be hearing the same type of aggressive tightening rhetoric out of Jerome Powell.) This is because the Fed knows that an inverted 2s10s essentially flags a recession with extremely high probability. Second, it means that we have not entered the stage when the Fed reverses its policy from tightening to easing. That occurs when the yield curve steepens. Yield curves steepen when short-term rates crater as traders front run rate cuts. We have witnessed absolutely none of this type of trade in the spot market. In the forward market, however, we see a policy reversal being priced in, but at least a year away. Rates markets are pricing in a series of hikes this year, resulting in future cuts when the economy inevitably enters contraction (or a liquidity crisis, which is harder to predict than a recession).