As we expected, the median projection for Fed Funds shifted forward and the headlines tomorrow are going to read, “Fed Projects Two Hikes in 2023!” Ummm, no.
Although the FOMC kept rates unchanged, 13 of 18 members believe the Fed will hike twice in 2023. Six weeks ago, just 7 of these members believed that. This is a notable change, particularly in such a short amount of time.
Of course, we have no way of knowing if Powell is one of those shifts, or which voting members switched. In Monday’s newsletter we wrote, “Even if some of the individual dots shift forward slightly and changes the headline to read, Fed forecasts first hike in 2023,” I’m not sure it matters. Unless Powell gets replaced in February, his dot is the one that matters. Not all dots are created equal.”
In the chart below, each of the 18 dots is given equal weight. Do we really believe that Richmond Fed President Thomas Barkin carries the same weight as Powell? Give me a weighted dot plot, and I’m more likely to believe it. Or, attach names to the votes so we can weight it ourselves. In his press conference, Powell even said, “Projections do not represent a committee decision.”
Fed officials, like everyone emailing us daily, aren’t immune to the feeling of runaway inflation. But, if at this time next year, inflation is running 1.5%, does everyone still expect a hike? Powell addressed this, saying, “There’s a possibility inflation could be quite low going forward.” And if he’s wrong, he reminded everyone that the Fed will pounce all over persistent inflation.
Most importantly, Powell noted that, “Individual projections and did not have a discussion about whether liftoff in a certain year would be premature. The dots are not a great forecaster of forward rate moves. Dots are to be taken with a big grain of salt.” Zing! In other words, “The only dot that matters is mine.”
This is as close to a flying Superman punch as you will get from a Fed Chair.
Source: Bloomberg Finance, LP
Don’t forget – the Fed’s new framework for inflation is an average inflation level of 2.0%. Inflation can run hot this year without the average inflation running above 2.0%. They aren’t hiking. Settle down, market.
On tapering, Powell was getting frustrated and just said, “We will taper when the economy experiences substantial further progress. That’s it.” Doesn’t sound like someone on the verge of tapering, nor does it sound like someone overly concerned about a taper tantrum.
Consider Buying 2 Year Caps Instead of 3 Year Caps
The market doesn’t care and decided to (over)react. The belly of the curve got crushed, with 5 year rates up 10bps.
For most of our clients, the biggest near term impact is that caps will be more expensive. 3 Year swaps are up 6bps, a 14% increase. That will increase cap costs. When able, you should seriously be examining 2 year caps instead of 3 year caps (read more here).
The 10T is up 0.075% as of this writing, to 1.565%. But the belly of the curve has experienced the biggest correction.
2T + 0.035% (0.20%, the highest in a year)
3T + 0.06%
5T + 0.10%
10T + 0.75%
Lastly, Interest on Excess Reserves (IOER) was increased 5bps to make sure Fed Funds wouldn’t go negative.
Bottom line – the market is overreacting to the dot plot. That doesn’t help you if you’re pricing a cap this week, but I suspect the front end will settle down given enough time.