Developments after the FOMC… Although no new bands were added on the 50 bps guidance at the Fed's last meeting, the trend revealed by the latest inflation indicators shows that hawkishness may still be valid in the extent of the tightening. What kind of analysis will be made in Powell's WSJ interview with a number of Fed members who will make statements this week will be important. Arguments seem to be out of date, as inflation is caused by temporary factors, namely the pandemic and public health. Inflation also tends to rotate from the usual suspect inflation of goods to the rigidity of services inflation.

 

The threshold to exit autopilot in Fed strategy… The Fed and Powell did not emphasize 75 bps increases, and the $95 billion balance sheet reduction, which forms the main line of QT, is below the 120 billion dollar growth and indicates a slower autopilot image compared to Treasury borrowing. There are two bands that the Fed can shift in to improve the situation: The first is to increase the neutral rate (unemployment, inflation, the level where it is assumed that growth will be in balance) by affecting the economy with interest rate increases of 75 bps. The second is that balance sheet reductions are also realized through redemptions and the sale of active bonds outside of predetermined bands. No developed country central bank is doing such a strategy at the moment. When it is done, the forerunner will be the Fed.

 

Fed future funds interest rate projections… Source: Bloomberg, CME Fedwatch

 

Goods-services rotation in inflation… The current CPI report casts doubt on the validity of the idea that moderation in commodity prices will be enough to bring inflation down to the Fed's optimistic forecast level by the end of the year. Services inflation is heated and, given its stickiness, much faster price declines are needed to come close to the Fed's forecast, assuming food and energy prices are also acting risk-inducing as expected. If the Fed cuts services inflation by curbing demand in its control area, there is a possibility that it will stifle activity while also increasing the chances of an economic recession. The easing of supply constraints is necessary to decrease the inflation of goods, and the restriction of demand is necessary to decrease the inflation of services.

 

Conclusion? The main issue is how hawkish the Fed can be. CME Fed rate expectations are pricing an additional 200 bps rate hike within the framework of the 50 bps rate hike standard until the 14 December 2022 meeting, which is likely to be subject to pricing above this band. The last 75 basis point increase in the markets was in 1994. The Fed is still showing a seriously hawkish trend. Thus, the relative pigeon perception of the last FOMC meeting did not have a very lasting effect. The Fed's moves to increase real interest rates and Powell's Volcker threshold will put the economy in a very slowing cycle, which will affect many sectors, especially the mortgage market, in terms of financing and demand. How much this will be needed to fight inflation, the trend of the rotation of goods and services inflation will show this.

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