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The situation compels. The Federal Open Market Committee members voted for yet another rate hike. The new range is 1.5-1.75%. Thus, the regulator looks forward to slowdown the inflation pressures in the country. It should be mentioned that the balance sheet reduction plan remains unchanged changed: from 1 June, it will be reduced at a pace of $47.5 billion per month and, in three months’ time; the reduction will be accelerated to $95 billion.
At the July meeting, the Fed will have to choose between a rate hike of 50 or 75 basis points. According to Jerome Powell, the final decision will depend on macroeconomic indicators. In terms of forecasts, the dot plot has shifted to a higher target of 3.25-3.5% for this year and 3.5-3.75% for next year. Investors in the interest rate futures markets estimate at 89% the probability that the Fed will raise rates to around 4% or more by June 2023. It is worth noting that four weeks ago this probability was 1%, according to the CME Group.
On the macroeconomic data side, the Fed expects inflation to accelerate to 5.2% from 4.3% in 2022. Next year, the estimate is lowered to 2.6% from 2.7%. The core inflation forecast for this year has been raised to 4.3% from 4.1%. The US GDP growth forecast has been lowered to 1.7% from 2.8%. The growth estimate for 2023 is lowered from 2.2% to 1.7%. As for unemployment, in contrast to previous revisions, the estimate has been raised from 3.5% to 3.7% (and from 3.5% to 3.9% for next year).
In Europe, ECB members pledged to provide all necessary support for Italy’s bonds and other affected countries. In addition, officials promised a more flexible approach to reinvesting financial instruments accumulated during the pandemic in order to keep the monetary policy transmission mechanism functioning. Another innovation will be the creation of a tool to combat unwarranted spikes in bond yields in the eurozone.
The problem is that the risk of fragmentation is still in the air. Going forward, this means that reasons for market nervousness will abound in the near future. However, it is worth remembering that the ECB’s main task is to ensure price stability and not to provide favorable financing conditions. Keeping spreads low could lead to so-called monetary financing, whereby the central bank buys government debt (part of it).
All that remains now is to wait for the July meeting when the interest rate is expected to be raised by 25 basis points. It should also be recalled that the regulator has decided to stop buying net assets under the APP program as of 1 July 2022. The reinvestment of payments on maturing securities purchased under the APP will continue in full for an extended period of time after the start of the rise in key interest rates.
