Wentz Weekly: Fed Delivers More Hawkish Tone

Wentz Weekly Insights
Fed Delivers More Hawkish Tone

The Federal Reserve’s Federal Open Market Committee (FOMC) concluded its meeting last Wednesday with a post-meeting statement that contained no surprises and remained relatively unchanged from the FOMC April meeting. The surprise was in the Fed’s Summary of Economic Projections (SEP) and its “dot plot.” The SEP showed the Fed expects stronger growth and higher inflation this year while growth and inflation expectations in 2022 and 2023 remained largely unchanged. However, the bigger surprise was in the dot plot. The dot plot indicates each Fed member’s judgement on where they anticipate the appropriate interest rate should be at a future date. The consensus still sees the first rate increase in 2023 but the dots indicate a shift upwards of 50 basis points (0.50%), with 13 of the 18 members now seeing at least one rate increase in 2023 and 11 of those members seeing at least two increases in 2023. Furthermore, an additional three members see the first increase in 2022, bringing the total to seven. We believe bonds sold off on this news with the yield on the 10-year U.S. Treasury note increasing 9 basis points to 1.58% after the release.
In Chairman Powell’s press conference, he reiterated his and the Fed’s view that inflation pressures are transitory but did acknowledge that some inflationary forces could be more persistent. Powell noted short-term increases in prices are due to certain reasons that should fade over time, and even decrease. On the labor market, Powell said the Fed expects a robust labor market in the years ahead but noted the likelihood the participation rate could remain low due to demographic trends and increasing retirements, something that will result in a lower labor market supply for longer than expected. What we were looking most forward to was the discussion on tapering the Fed’s $120 billion in asset purchases per month. The Fed, as expected, did not change this policy and had very little to add on timing of tapering. Powell did however say to think of this meeting as the “talk about talking about” meeting. We view this as Powell preparing the markets that the Fed will begin more detailed discussions on tapering at one of the next meetings. An important date coming up is the annual Jackson Hole Economic Symposium beginning August 26. The event is known to be a time the Fed announces major economic policy changes. At its meeting last year, Powell adopted the Fed’s average inflation targeting policy which was a major shift in its inflation policy. We will keep this date circled on our calendar as a likely date the Fed will make a bigger announcement on beginning the talks of tapering and possibly details on its plans, although we don’t believe actual tapering will happen until at least the end of the 2021 or early 2022.
Following the Fed meeting markets immediately priced in the chance of a sooner rate hike. According to futures, the market is now pricing in a 44% chance of at least one rate hike by the Fed’s July 2022 meeting, up from a 30% chance prior to the Fed meeting. Treasury yields on the shorter end of the yield curve rose while longer dated yields declined. The 2-year Treasury yield was up from 0.17% to 0.21% after the meeting and closed the week at 0.28% while the yield on the 30-year bond rose 0.03% to 2.20% after the meeting but fell back down to 2.01% by the end of the week. It may be the case the market became concerned rate hikes could outpace economic growth, which is what caused the yield curve to flatten. In addition, Friday morning involved an interview by St. Louis Fed President James Bullard. A known hawk, Bullard said the taper talk discussion is now open, but will take several meetings to organize and the Fed’s inflation goals would be met by this meeting or next. All of this confirms our thoughts the Fed has already began its discussion on tapering and an announcement will be made at some point in the second half of 2021.
More signs of inflation pressures are evident in the producer price index report, which was released last week for May by the Bureau of Labor Statistics. The report showed input prices that producers of goods pay rose a higher than expected 0.8% in the month and are 6.6% higher compared to the same month a year ago. Excluding the volatile food and energy categories, the price index is 5.3% higher than a year ago. Higher producer prices could lead to higher prices for consumers as some businesses may decide to pass on the higher prices to the consumer.
Retail sales in May showed a large shift in consumer spending habits thanks to the increase in vaccination rates, wider spread economic reopening, and the effects of government stimulus fading. Retail sales in the U.S. fell 1.3% in May, a steeper drop than expected, reflecting less spending by Americans compared to the stimulus-inflated months of March and April when most received their stimulus payments. In addition, a shift in spending habits was notable as more Americans spent money on services such as eating out and things they couldn’t do during the pandemic. Spending on bars and restaurants rose 1.8% in the month with sales at food service places now higher than pre-pandemic levels. Online sales declined, indicating a pivot to more in person shopping. Clothing sales (such as department stores) rose 3.0% in the month as more people prepare to go out more often. Consumers spent less on big ticket items such as vehicles, furniture, electronics, and building materials, categories that boomed during the pandemic months.

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