Ahead of the next meeting of the Federal Open Market Committee (FOMC) on May 3-4, 2022, markets anticipate that it will decide to raise the federal funds rate by 50 basis points (bps), raising the target range from the current 25 -50 sc to 75-100 sc. This mirrors comments made by Federal Reserve Board (FRB) Chairman Jerome Powell during a seminar sponsored by the International Monetary Fund (IMF) on April 21, 2022. He said that an interest rate increase of “50 basis points will be on the table for the May meeting”.
In addition, the FOMC is likely to start reducing its balance sheet “considerably faster than in the previous recovery,” as Federal Reserve Governor Lael Brainard stated in a speech on April 5, 2022. “It is of the utmost importance reduce inflation,” she said.
- The Fed is likely to raise the federal funds rate by 50 basis points (bps) at its meeting on May 3-4, 2022.
- More rate hikes are expected to follow, with the aim of reducing inflation.
- Markets anticipate the fed funds rate to exceed 3% in early 2023.
- The rapid shrinking of the Federal Reserve’s $8.9 trillion balance sheet is a related item on the agenda.
- At the last FOMC meeting, in March, cutting the balance sheet by $95 billion per month had general support.
During the IMF panel discussion, Powell insisted that “getting inflation back to the 2% target” is a critical policy imperative right now. He noted that it is “absolutely essential to achieve price stability” as a means of achieving both labor market stability and general economic stability.
Powell added: “Our goal is to use our tools to synchronize demand and supply, without a recession.” Meanwhile, he noted that several FOMC members favor one or more rate hikes of 50 bps each, but did not disclose his own position.
Fed Balance Sheet Reduction
In his speech, Brainard indicated that the last period of balance reduction was in 2017-19. During this time, the Federal Reserve cut it by about $50 billion a month. According to the minutes of the last FOMC meeting, held on March 15-16, 2022, members generally favored setting the initial balance sheet drawdown rate at about twice that rate, or about $ 95 billion per month.
In fact, all of the options presented by Fed staff for balance sheet reduction at that meeting involved a faster balance sheet “tie-breaker” than was implemented in 2017-19. Furthermore, all participants agreed that the combination of high inflation and a tight labor market require a faster runoff pace than in 2017-19.
As points of reference, the size of the Fed’s balance sheet was a record $8.9 trillion in the week beginning April 25, 2022. This is more than double the range of around $4.4 trillion that it existed from mid-2014 to early 2018, and has also risen significantly from a recent low of around $3.8 trillion in mid-2019.
The Federal Funds Effective Rate
At its meeting on March 15-16, 2022, the FOMC voted to increase the target range for the fed funds rate by 25 bps, from 0-25 bps to 25-50 bps. The effective federal funds rate (EFFR), the volume-weighted median of overnight federal funds transactions, has been near the lower end of those ranges. Until March 16 it was at 8 bp. As of March 17 it is at 33 bp, precisely 25 bp more than before.
What the markets predict
The CME FedWatch Tool and the Atlanta Fed Market Probability Tracker are based on complex analyzes of securities whose price is determined by expectations about interest rates in general and FOMC policy moves in particular. Both assign ranges of probabilities to decisions on the fed funds rate at future FOMC meetings.
CME FedWatch Tool 2022 projections
On the morning of May 2, 2022, CME’s FedWatch tool anticipated this pattern of future rate increases emerging from the remaining FOMC meetings currently scheduled for 2022:
- May – 50 bp increase to a new target range of 75-100 bp
- June – 75 bp increase to a new target range of 150-175 bp
- July – 50 bp increase to a new target range of 200-225 bp
- September: roughly equal odds for a new target range of 225-250bps or 250-275bps
- November: roughly equal odds for a new target range of 250-275bps or 275-300bps
- December: roughly equal odds for a new target range of 275-300 bps or 300-325 bps
Atlanta Fed Market Probability Tracker Projections for 2022
Meanwhile, the Federal Reserve Bank of Atlanta’s Market Probability Tracker projects that the most likely path for the three-month average fed funds rate, currently at 33 bps, would be:
- May and June: up 130 bp accumulated up to 163 bp
- July to September: up 77 cumulative bps to 240 bps
- November and December: up 43 bp accumulated to 283 bp
Projections for 2023
Looking further ahead, CME’s FedWatch tool anticipates that the target range will most likely be 350-375 bps by July 2023. The Atlanta Fed Market Probability Tracker anticipates a three-month average fed funds rate of 322 bps by then.