Fed minutes hint at hawkishness with wiggle out room

On 16-February, the US Federal Reserve announced the all-important minutes of the Federal Open Market Committee (FOMC) meet held on 25th and 26th January. The broad message was that rate hikes would start from March 2022. However, the Fed has affirmed that subsequent decisions on further rate hikes would be decided based on data.

What now looks like, as is evident from the minutes is that the Fed will hike rates, most probably by 50 basis points (0.50%), in the Mar-22 Fed meet. The US economy is facing its highest inflation at 7.5% and the fastest rate of price increases since 1982. However, the Fed still expects inflation to ease through most of 2022. Hence the Fed has kept future rate action open and data based. It will be decided on a meeting-by-meeting basis.
 

Check - FED Hints at Rate Hikes from March 2022

What does the CME Fedwatch tell us about likely rate hikes?

The CME Fedwatch captures the future pace of rate hikes based on the Fed Futures trading. It is more a market based measure and the actual Fed prescription could be entirely the opposite. However, here is what the CME Fedwatch tells us about future rate action.

A) It is looking almost certain there the first rate hike will happen in Mar-22, and Fed future are hinting in a strong possibility of a 50 bps rate hike as a front-end push.

B) The CME Fedwatch estimates that by June 2022 there is a strong likelihood of Fed rates rising by 100 bps to the range of 1.00% to 1.25%.

C) By end of calendar year 2022, there appears to be a likelihood of 150-175 bps rate hike and the front ending has increased since the FOMC meet in January.

D) Markets expect Fed rates to stabilize near the long term target of 200-225 bps by Feb 2023, which syncs with the estimates of Goldman Sachs also. 

The Fed futures, at this point of time, are building in a lot of hawkishness on the back of sharply higher inflation, though the inflation tapering is not being considered.

What we understand from the FED minutes on 16-February

The gist of the minutes are that rate hikes are coming soon. However, Fed remains confident that inflation will taper during the year and that remains an alternate scenario.

a) Fed has hinted at a first rate hike in March but stopped short of giving any longer term guidance beyond March 2022. The Fed would rather stick to a data driven approach to rate action and take it up on a meeting-by-meeting basis after March 2022.

b) Fed stays confident that eventually inflation would ease in 2022, although inflation has been quite deceptive in the past. Hence, the Fed has still kept a wiggle room open in the form of Plan-B, should inflation start falling rapidly. 

c) However, if the inflation continued to be sticky, the Fed may use the dual weapons of rate hikes and bond book unwinding. The liquidity tightening by way of a drawdown on the $9 trillion Fed bond book may also start off vigorously.

d) The consensus of the members of FOMC is that rate hikes could be more frequent than once a quarter. For now, the bet is on a 50 bps rate hike in March 2022 as the negative gap between the Fed rate and rate of inflation; is the deepest in the developed world.

e) Interestingly, the bond yields on the 10-year US benchmark has tapered sharply from a high of 1.92% to around 1.52%. This betrays the market assessment that given a choice the Fed would still be keen to ensure that economic momentum was not impacted.

Does the FED minutes have any impact on India?
 

In a way, when the US markets sneeze, it does rub off on India. Here are 3 ways the Fed minutes could have an impact on India.

1) It is time for Indian markets and the Indian central bank to be realistic and prepare for a 50 bps rate hike in March 2022. In the past, the first rate hike has normally induced a good deal of volatility in Indian bond markets, apart from the equity and forex markets.
 
2) The more pressing concern will be the upcoming LIC IPO, which is likely to be open around the time of the March Fed meeting. If the March Fed is more hawkish than anticipated most of the institutional investors globally are likely to get cautious.

3) Lastly, it is about the RBI stance for the April meeting. The Fed minutes put a greater onus on RBI to plan to hike rates in April. If it is 50 bps in March by the Fed, then it is inevitable for the RBI to look at a rate hike in its April policy, or even earlier.

Also Read:-

Glance of the FED Statement