Communication… The facts available after the FOMC meeting stand in the middle between whether there is a need for a faster tightening path, and front-loaded expectations making it sufficient to do much less with tight communication. While Powell clearly demonstrates his desire to increase interest rates in the near future, the participation of the Central bank balance sheet in this interest rate increase phenomenon will be an important part of the new monetary policy strategy. The fact that inflation remains uncomfortably high indicates that the currently predicted phenomenon will be in the form of double-sided tightening. While the central bank reduces the balance sheet, it will not create a long waiting period.
Rate hike at the March meeting… Unless there are unexpected economic developments until the next FOMC meeting on March 16, there will be an increase in the federal funds rate. The move in expectations and the increase in the implied year-end funding rate raise the possibility that the central bank will act more than we currently anticipate if inflation remains uncomfortably high.
Reinforcement due to balance sheet reduction… While the Fed will increase interest rates, it will also reduce the balance sheet, but considering the bilateral effects of the tightening phenomenon, we think that there will also be balance monitoring in order not to cause collateral damage to the economy. Therefore, it makes sense to have a short ‘esc’ between the first rate hike and the first balance sheet reduction move, on the other hand, we think that the first phase will depend on the autopilot mechanism through some redemptions.
Comparison of slope on the US yield curve… The curve in yellow represents the positioning one month ago, while the curve in green represents the current positioning. Source: Bloomberg
Yield curve slope… It is understood that the yield curve has shifted towards a steep slope in line with the expectations that changed compared to a month ago. Of course, due to the growth position of the economy in the long and short term, the stability of the slope is also very important. This is the reason why interest rates should not be raised too quickly in order to avoid the recession phenomenon in the economy. An inverse slope of the yield curve will occur when short-term interest rates are higher than long-term rates. Currently, the yield curve is positively sloped since the interest rate on long-term borrowing is higher. Flattening the curve or making the slope less steep is important in this respect; management of inflation expectations. The rise in long-term interest rates indicates the expectation that inflation may remain high over the longer forecast horizon. However, the main problem is not that the interest rates increase as the maturities extend, but that the interest rates increase steeply. Yield curve control can be achieved directly or indirectly through monetary policy tools and does not require a formal target disclosure. Expectations stabilized in the short term also spread to the long term and keep the interest on borrowing at reasonable levels. The job is to manage inflation expectations.
Conclusion? The more the central bank is concerned about managing inflation expectations, the more effective it must be in accelerating the tightening path. The FOMC said it “will be prepared to adjust its monetary policy stance appropriately if risks arise that could prevent the achievement of committee targets.” We see risks evolve towards a faster-moving Fed.
Kaynak: Tera Yatırım
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