Market Awaits the Fed
It’s FOMC Day and we delve into more detail below what we think comes of this meeting. This is one of those quarterly affairs where the Fed updates its economic and rate projections and those often provide more insight than the carefully-crafted statement and heavily-scripted post-meeting press conference. Suffice it to say, we think Chair Powell will be his usual dovish self, but perhaps just a little less so. He will, however, still profess patience in meeting the employment mandate, what with 8 million, or so, still missing from employment rolls since the pandemic hit. The timing of tapering asset purchases will no doubt get asked about in the press conference, but we think Powell will be careful to remain vague around the subject until later this summer. Finally, in this week’s podcast we sat down with Tom Michaud, CEO of KBW, and discussed M&A and the future of community banking in the post-pandemic environment. If you’ve been interested in being a buyer or seller you’ll not want to miss this episode. The iTunes link can be found here and the Spotify here.
The FOMC meeting concludes later today and we wanted to share some things we think will come out of the meeting and some things we think won’t. Being a quarter-end meeting it carries with it updated economic and rate forecasts and we think those updated forecasts/projections could be the one of the highlights of today’s meeting.
- First, while the market has been busy pricing in a first rate hike in 2023, the Fed is also likely to pull a rate hike from 2024 into 2023. At the March meeting, seven members penciled in 2023 rate hikes, with two projecting the ending rate at 1.125%. The median, however, was tenuously in the zero lower bound camp. It would take just two additional members to join the seven from March to move the median off zero. We’re splitting hairs here but suffice it to say the new dot plot will get serious scrutiny.
- The new economic forecast is likely to come in for improvement. In March, the Fed forecast 2021 GDP at 6.5% versus the current Bloomberg consensus at 6.6%. With a second quarter GDP forecast of 10%, it’s easy to see why some upward adjustment to 2021 GDP could be in the offing. How high? Well, perhaps not quite 7%, but close. Also, in March the Fed had core PCE rising to 2.2% this year before falling again to 2.0% in 2022. We think given the inflation numbers of late, that the 2021 core PCE could be due for a tenth or two upsize. Will it return to 2.0% in 2022? That will put the transitory question to a test. It will be interesting to see how quickly they forecast it falling back to their 2.0% benchmark.
- The unemployment rate forecast may pose a stickier problem. In March’s forecast, 2021 unemployment was projected to be 4.5%. We’re currently at 5.8% but the last few months have seen a decided slowing in improvement. Nearly 12 million are receiving supplemental unemployment benefits that are soon to expire. Will they re-enter the labor force and suddenly expand the pool of unemployed looking for employment? Several Fed officials have been on record that the well-known unemployment rate by itself is not a good indictor of labor market health. With the labor force shrinking by nearly 5 million over the last year, and many of those likely to return soon, it seems the unemployment rate is due for some volatility in the months ahead so the Fed is likely to look to additional measures to gauge labor market health.
In the end, we think the Fed will want to project a steady-as-she-goes approach at today’s meeting. No change to current policy nor any contemplation at this time of changing policy in the near future. The Fed still sees 8 million unemployed from the pandemic and another 4 million having left the labor force, and until those numbers improve significantly the Fed will see its work as undone.
5-Year Treasury Yield Poised to Head Higher?
With this being Fed Day, we thought we would look at perhaps the maturity most sensitive to future fed funds rate expectations and that is the 5-Year Treasury. While shorter maturities are tied closely at the hip of the fed funds rate, the 5-year is sensitive to not only the initial lift-off of rate hikes, but the expected pace of subsequent hikes.
As shown in the graph provided by Citigroup, after the first three months of higher yields in 2021, the last three months have been about consolidating the initial move higher. Citi’s point is that with the right signal from the Fed that rate hikes might come sooner, and perhaps faster than previously forecast, yields are poised to reclaim much of the drop in early 2020. While the Fed may move the initial rate hike forecast into 2023, we remain suspect that they will signal much beyond that at this point and that should limit 5-Year yield increases for now.
Agency Indications — FNMA / FHLMC Callable Rates
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