- FOMC statement: The tone of the Federal Open Market Committee (FOMC) statement was hawkish, with a focus on higher inflation risks and more aggressive policy tightening. There were notable changes to the statement: the Fed retired the word ‘transitory’ to describe inflation; the Fed pointed to the recent inflation developments that directly led to a speeding up of tapering; the Fed announced that it would double the pace of tapering of its net asset purchases. The monthly reduction in such purchases will be $20bn for Treasury securities and $10bn for agency mortgage-backed securities (MBS) in January, up from the earlier monthly pace of $10bn for Treasury and $5bn for agency MBS. This pace is likely to end the Fed’s asset purchase programme by mid-March.
- Economic projections and rate expectations: The Fed is projecting the economy to expand 5.5% in 2021 and 4.0% in 2022. They offered sharp upward revisions to Core PCE projection for 2021 (from 3.7% in September to 4.4%) and for 2022 (from 2.3% to 2.7%). There was also a sharp downward revision to the 2021 unemployment rate forecast, from 4.8% to 4.3% over the past quarter. The Fed members offered dramatic changes to the Federal Funds rate projection, with the median year-end 2022 rate moving from 0.125% to 0.875%, the median year-end 2023 rate moving up 0.75% to 1.625%, and the median yearend 2024 rate moving up 0.50% to 2.125%. In 2024, the median projection stands at 2.00- 2.25%, just below the Fed’s terminal rate of 2.50%. There were five ‘Dots’ that came in higher than the terminal rate (longer-run projection). The Fed’s concern on inflation was the prominent theme of the press conference. Chair Powell raised the possibility of an earlier start to quantitative tightening. He emphasised that the economic and inflation circumstances are much different now compared to the last cycle.
- Market reaction and investment implications: The outcome of the FOMC meeting was more hawkish than expected. Market reaction was muted for fixed income, while it was positive on equities despite the hawkish Fed tone. The equity market reaction exemplifies the trust in the Fed’s ability to master inflation while not hurting economic growth. While twoyear Treasury yields have priced in fully the FOMC’s projected pace of rate hikes, intermediate- and longer-term Treasury yields have not. We see risk of a bearish steepening of the yield curve. This reinforces our negative view on duration and is generally positive for value equities relative to growth equities. Despite the Fed’s shift to reducing accommodative monetary policy, policy will remain accommodative in 2022, as the Fed Funds rate was forecasted to be well below the ‘neutral’ rate. Such easy financial conditions will be supportive of risk assets. Solid consumer fundamentals should support the broader consumption as well as housing markets, which underpins our positive view on securitised credit investments.
In the final, and highly anticipated, FOMC meeting of 2021, the Committee delivered a more hawkish than expected message, with a focus on higher inflation risks and more aggressive monetary policy tightening. The financial markets reaction, which rallied broadly, reflected a different interpretation, for now.