- FOMC brings forward rate-hike forecast and begins QE tapering talksÂ
- Unemployment claims expected to show continued labor market improvement
- LEI expected to show another big increase
- 5-year TIPSÂ
FOMC brings forward rate-hike forecast and begins QE tapering talks — The outcome of the Tue/Wed FOMC meeting was more hawkish than the markets had been expecting. The FOMC began discussions about QE tapering and brought forward forecasts for rate-hikes in the latest dot-plot. The Fed also made a technical adjustment by raising its IOER and reverse repo rates, which put upward pressure on short-term interest rates.
The 10-year T-note yield rose sharply on yesterday’s FOMC results, posting a 1-1/2 week high and closing the day up +8 bp at 1.58%. The federal funds futures curve tightened by only 1 bp for the contracts through mid-2022 but tightened by about 5 bp for the 2023 contracts. The Eurodollar futures curve tightened by 2-5 bp for the 2022 contracts, 8-13 bp for the 2023 contracts, and 13-16 bp for the 2025 contracts.
The markets are expecting the Fed’s first +25 bp rate hike by early 2023 and are expecting a total of two rate hikes in 2023, according to the Eurodollar futures curve. The markets are expecting an overall +225 bp rate hike by late 2028.
The Fed’s latest dot-plot shows that FOMC members are now expecting rate hikes sooner than they were in March. The latest dot-plot showed that 11 of 18 FOMC officials now see two rate hikes by the end of 2023, up from only 5 members in March who were expecting at least two rate hikes. Moreover, 7 of 18 members now see a rate hike as early as 2022, up from only 4 in March.
Fed Chair Powell, in his post-meeting press conference, tried to downplay the importance of the dot-plot, but the fact remains that the dot-plot showed that individual FOMC members turned significantly more hawkish. Mr Powell said, “The dots are not a great forecaster of future rate moves. These are of course individual projections, they’re not a committee forecast, they’re not a plan. And we did not actually have a discussion of whether liftoff if appropriate in any particular year, because discussing liftoff now would be highly premature — it wouldn’t make any sense.”
The Fed also began discussions about when conditions might be right to consider QE tapering, which was in line with the Fed’s recent warnings. However, Mr. Powell downplayed the discussions by saying, “You can think of this meeting that we had was the ‘talking about talking about meeting,’ if you like.” He added, “we’re still a ways from our goal of substantial further progress.”
The news about QE discussions may have caused some market participants to move forward their expectations for QE tapering. A survey taken by Bloomberg in early June found that only 16% of respondents expect the Fed’s early-warning to take place in June or July. The largest plurality of 40% believe that the Fed’s early-warning will come at the Fed’s Jackson Hole Conference in August. The second-highest percentage of 24% believe the early warning will come in September. Only 14% of respondents expect the early warning to come in October or later.
The Fed yesterday also boosted its short-term administered rates by +5 bp, an event that carried odds of only about 30%. The Fed raised its overnight reverse repo rate by +5 bp to 0.05% from zero, and raised its interest on excess reserves rate (IOER) by +5 bp to 0.15%. The hike in those rates was designed to raise the floor for short-term rates and reduce the risk of rates going negative. The federal funds rate has recently been trading at 0.06%, which is 6.5 bp below the midpoint of 0.125% of the Fed’s 0.00%/0.25% target range.
Unemployment claims expected to show continued labor market improvement — The U.S. labor market today is expected to show continued improvement. The consensus is for today’s initial unemployment claims report to fall by -16,000 to 360,000, adding to last week’s -9,000 decline to 376,000. Today’s continuing claims report is expected to fall by -74,000 to 3.425 million, adding to last week’s -258,000 decline to 3.499 million.
Despite the steady improvement, unemployment claims are still elevated from the pre-pandemic levels by +160,000 for initial claims and +1.8 million for continuing claims. The U.S. economy still has to produce another 7.6 million jobs to get payroll jobs back to their pre-pandemic record high.
LEI expected to show another big increase — Today’s May U.S. leading indicators report is expected to show another strong increase of +1.3% m/m, adding to April’s increase of +1.6% m/m. The LEI showed big gains in March and April as the pandemic faded. The LEI in April was up sharply by +17.0% y/y.
The U.S. economy is currently red-hot as it recovers from the pandemic. The consensus is for U.S. GDP growth in the current second quarter to soar by +10% (q/q annualized), adding to the +6.4% gain seen in Q1. The market is then expecting GDP growth to remain very strong at +7.0% in Q3 and +4.9% in Q4, before fading to the +3.0-3.5% area in the first half of 2022.
5-year TIPS — The Treasury today will sell $16 billion of 5-year TIPS in the first and only reopening of the 1/8% 5-year TIPS of April 2026, which the Treasury first sold in April. The benchmark 5-year TIPS yield yesterday rose sharply by +19 bp to a 6-month high of -1.54%.
The 5-year TIPS is the second most popular coupon security among foreign investors and central banks, behind the 30-year TIPS. Indirect bidders have taken an average of 69.5% of the last twelve 5-year TIPS auctions, well above the median of 60.5% for all recent coupon auctions.
