In Brief

• On 15-16 March, the Federal Open Market Committee (FOMC) held its two-day meeting and raised its federal funds rate target range by 25 basis points (bps) to 0.25%-0.5%, with one dissenting member calling for a 50bps increase.
  
  
• Concerns around higher inflation were enough for the FOMC to raise rates for the first time since December 2018. However, uncertainties around recent geopolitical issues and their future impact on growth led to a measured 25bp first step in place of a 50bp leap.
  
  
• Global Liquidity portfolios are well-positioned to capture the uplift in overnight rates and stand to benefit from steeper curves and more aggressive expectations for Federal Reserve (Fed) tightening.  

The FOMC delivered on Chairman Jay Powell’s promise of a 25bps increase to its target range, which now stands between 0.25% and 0.5%, and moved up the Interest on Reserve Balances (IORB) and the overnight reverse repo rate (RRP) by the same amount, to 0.4% and 0.3% respectively. However, the well telegraphed hike was not without dissent, as one member would have preferred to see the target range increase 50bps.

The debate amongst FOMC members, given the belief that the labor market has largely met the conditions of maximum employment, was on how to handle higher inflation during a period of geopolitical uncertainty. The FOMC lowered its 2022 growth estimate versus its December forecast (real GDP -1.2 percentage point to 2.8%), and revised core inflation upwards (+1.4pp to 4.1%). This sentiment was echoed by Chair Powell, who mentioned that Russia’s invasion of Ukraine will likely add to inflation and subtract from growth. Ultimately, the FOMC majority erred on a measured initial first step waiting for more data, before making a larger interest rate adjustment. In the past, Powell has stressed being nimble and current evolving economic conditions likely warrant that. But this is not to say a 50bps adjustment cannot come at a later meeting.

The FOMC released its quarterly dot projections at the meeting, which summarizes its outlook for the federal funds rate. The median FOMC estimate now calls for seven hikes in 2022, up from an estimate of three hikes at the December meeting, reflecting its evolving stance on inflation. These projections are now more in line with market estimates that currently forecast the equivalent of between six and seven additional 25bp hikes in 2022 and indicate the potential for a 50bp increase at one of the remaining six meetings this year. This is in line with seven of the 16 committee participants who looked for more than six additional hikes in 2022. At this pace the median target would be 1.9% by year-end and with FOMC estimates for between three and four more hikes in 2023, the implied median target range could reach 2.75% before levelling off. This is notable given the FOMC’s long run median estimate is below that at 2.38%.

Balance sheet discussions continued at the meeting without any formal decision being made. With asset purchases concluding this month, the market is looking for further clarity on when balance sheet reduction will begin and what the pace may look like. The Fed stated in the March meeting that quantitative tightening will begin at an upcoming meeting, and that the minutes to last week’s meeting, released in April, will offer some insight into the passive runoff.

Investors Implications

We believe money market investors should welcome an increase in rates and steeper 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.

Unless otherwise stated, all data sources are from FOMC’s meeting dated 15-16 March 2022. 

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