- On May 5, the Federal Open Market Committee (FOMC) unanimously raised its Federal Funds Rate target range by 50 basis points (bps) to 0.75%-1.0%. This was the largest single meeting increase since 2000.
- The Federal Reserve (Fed) remains committed to raising rates “expeditiously” to bring down inflation, which is running at its quickest pace since the 1980s. However, the central bank’s future policy path has not been set in stone and remains adjustable to the changing landscape.
- Quantitative Tightening (QT) is expected to begin in June with assets rolling off at a pace of $47.5bn per month, potentially reaching a peak of $95bn per month. We believe the initial impact of QT on the money market space will be negligible.
- Global Liquidity portfolios are well-positioned to capture the uplift in overnight rates and stand to benefit from steep curves and aggressive expectations for Fed tightening.
May FOMC highlights
The FOMC met market expectations for a 50bps increase to its target range, which now stands between 0.75% and 1.00%, and raised the Interest on Reserve Balances (IORB) and the overnight Reverse Repo Rate (RRP) by the same amount to 0.90% and 0.80% respectively.
The Fed broke the mold of the previous two hiking cycles and chose to raise rates by the single largest amount since 2000. The Bank’s future policy path has not yet been set in stone and the door has been left open to adjust to the changing landscape. However, inflation is at its highest level since the 1980s, and the Fed remains highly attentive on inflation risk, stating that it wants to get to neutral expeditiously and even beyond if necessary.
When asked about future policy path during the press conference, Chairman Powell continued to stress being nimble. Ultimately, the Fed wants to maintain flexibility. However, Powell did state that a larger 75bps hike is not currently being considered by the Committee, and that incremental 50bps hikes are on the table for the next couple of meetings.
Markets reacted to these statements, pricing out the probability of 75bp hikes at one of the next two meetings. Ahead of the press conference, market estimates for future rate moves continued to get more aggressive (fig1.) and had at one point priced in a 40% chance of a 75bp rise. The belief was that the Fed was potentially falling behind the curve and needed to be even more aggressive in order to clamp down the hottest inflation in the last 40 years. However, Powell’s comments suggested that there is some evidence that inflation may have peaked and this is perhaps why he signaled 50bp moves for the next two meetings rather than something even more aggressive.
As for the remainder of the year, the market expects between seven and eight additional 25bps hikes, which would take us beyond the Fed’s current median neutral rate estimate of 2.38% by year-end.
Figure 1: Fed Fund Futures implied overnight rate time series
Source: Bloomberg, as at 5 May 2022.
On the balance sheet, the Fed chose to begin QT in June with assets rolling off at a pace of $47.5bn a month ($30bn treasuries and $17.5bn mortgages) and after three months will peak at $95bn a month ($60bn treasuries and $35bn mortgages). This is faster than the last QT, which reached a peak of $50bn a month ($30bn treasuries and $20bn mortgages). The initial impact on money market rates should be minimal. Treasury bills will only roll off to the extent the monthly treasury cap is not reached through maturing Treasury coupon securities. Also, demand for short term product remains high while relative supply is low, which is illustrated by elevated RRP balances above $1.8 trillion. In the interim, it is likely these driving factors will prevent short term money market rates from leaking higher within the Fed’s target range.
We believe money market investors should welcome a series of increases in rates and steep Fed trajectory. The short average maturity of money market funds, due in part to the substantial positions held in overnight to one week maturities, allows for funds to quickly reset a significant portion of their portfolio higher. As a result, Global Liquidity portfolios could be well-positioned to capture the uplift in overnight rates and stand to benefit from steeper curves, wider spreads, and continued tightening by the FOMC.
Source for all data is J.P. Morgan Asset Management as at May 5 2022, unless otherwise stated.
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