Increased Economic Risk Impact in Fed Hawkishness

Fed decisions and the interest rate band… While the 75 bps rate hike decision of the Fed, taken at the 14-15 June meeting, continues to be evaluated by market actors, communication guidance is still followed within the framework of receiving a clear message about the policy approach for the future. Federal funding rate range was increased by 75 basis points for the first time since 1994, thus the new funding band was determined as 1.50% – 1.75%. This interest rate decision was not taken unanimously, however, it was a meeting decision in which one of the members expressed an opinion as a continuation in the 50 bps band. The highlights from Powell’s Congress presentations are also important as they show that economic decision makers see recession as a possibility. In the current direction, the US 10-year yields are down to 3.06%.

Expectation channel for main economic parameters… The Fed had to significantly change its growth and inflation forecasts compared to the March meeting. This is due to the fact that the image is not as optimistic as 3 months ago. The previous guidance on growth was that economic activity was generally in a weighted recovery state. Now there is a lower growth path prediction. It is understood that there is still a long way to go in terms of the revision degree of the current projections in terms of achieving the 2% inflation target. While domestic demand remains high, it is very likely to come down due to the current tightening, economic slowdown and inflation effects. The employment market, on the other hand, maintains its tight and strong image as the data set the course, while the following period shows that the Fed has created a tolerance band for a certain increase in the unemployment rate.

Fed funding rate, Eurodollar December contract, Fed dots chart long-term interest rate projection comparison… Source: Bloomberg, Federal Reserve

Interest rate communication… The fact that the Fed’s latest interest rate move has followed a market expectation that has changed in a few days shows that the usual forward-looking guidance has not been followed. Therefore, it turns out that the forward commitment bands do not constitute a 100% reference regarding the Fed’s interest rate moves, and the important thing is the direction of the forward pricing. The Fed will probably continue to increase interest rates in the 75 bps band at its July 27 meeting. The fact that the 50 bps interest rate increase threshold, which was last applied in 2000, was increased towards the 75 bps interest rate increase band, which was last applied in 1994, is a remarkable detail and reveals that the Central Bank has taken a more hawkish attitude towards proactiveness. The Fed will probably have brought the upper band of the funding rate to the 2.5% band as of July, and to the 3.5% band by the end of the year.

Conclusion? The tighter image in the federal funding rate range is the policy plan preferred by the Central Bank as it provides a quick response mechanism against high inflation. At the 27 July meeting, the probability of a rate hike step is quite high, at least as much as the one implemented in June. The suppression of demand by high interest rates and the lowering effect of the more valuable dollar on import costs are the facts that the Central Bank relied on in the first stage of its planning in the fight against inflation. Regarding the interest bands, the door is left open to the possibilities of +50bp or +75bp in the movement thresholds of the near months. The movement area in interest rates, on the other hand, is the thought that the economy can carry interest rate increases with its current strong position.

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