Fed Goes with 50 bps in May ‘22
Powell spoke this week and we all listened, tuning into one of the perhaps most important Fed Reserve chairman press conferences this year. While Fed board members alluded to the idea of 75 bps hike in the weeks leading up the announcement, no such hike materialized. Instead, a softer 50 bps rate hike was delivered, still very much along the consensus lines of popular opinion. Further, Powell squashed the idea of 75 bps increases as something the committee is not “actively considering.”
A 25 bps difference may not seem material, but the decision tells us a lot. Prior to this week’s 50 bps hike, the Fed only raised rates to 25 bps from 0 bps, where it sat throughout the pandemic. With rampant inflation growing by the day in the short time between the two meeting, speculation abounded the Fed would take more drastic measures. Instead, the Fed outlined the prospect of only 50 bps rate hikes moving forward, still high but nowhere near the psychological bomb of a 75 bps hike. Perhaps this more circumspect move reflects the increasing impossible tightrope walk the Fed must now walk between taming generationally-high inflation and staving off recession, something definitely in the cards for later this year.
Inflation took center stage in the rest of Powell’s comments. It’s an issue he’s taking seriously, but one he thinks can be managed while avoiding recession. Possible, but not easy. He sees inflation as nearing a peak or even flattening, the possible reason for choosing a mere 50 bps for this week’s rate hike. He also expressed confidence in the current state of businesses being in “good financial shape” and a “very strong” labor market supporting the economy. I did find it interesting to note his comment on admiration for Paul Vaulker who “had the courage to do what he thought was the right thing.” Will we see the same from Powell? With political pressure to avert the start of a recession ahead of mid-term elections in November persuade him to back off?
On a final note, the stock market cheered the prospects of “only” a 50 bps rate hike this week, letting bearish option calls around a 75 bps hike unwind, and then proceeded to implode the next day, sending the index down 5% for the NASDAQ and 3.5% for the S&P on the day immediately following and another 2% and 1.5%, respectively, the day after. The NASDAQ is now down more than 25% off its high and the S&P by a slightly less 15%. Clearly market participants are reading into the bigger message that multiple 50 bps hikes are in the cards, a drastic tightening from the Fed. Further, the Fed is more quietly reducing its multi-trillion dollar balance sheet, vacuuming out significant liquidity from capital markets on the margin.
Only certainties I see moving forward are higher volatility and lower asset prices, across the board. We’ll keep an eye on the spillover effect into real estate as well, which is also not immune to rate hikes as the 10-year is officially over a 3% yield, marching far ahead of the Fed’s announced hikes. By my measure, this would knock somewhere around 5% - 10% off the purchase price of a property purchased early this year when yields were 1.5%. A shift is underway, worthy of time and attention to capture the nuances of rapidly changing bond yields and Fed rates, likely kicking of a very rocky stretch in the 6- to 18-months ahead.