Fed policy tightening

While the Fed is preparing for the first rate hike, the opinions that this step might be bigger than normal started to dominate the market.

How fast can the Fed speed up? While the Fed is preparing for the first rate hike, the opinions that this step might be bigger than normal started to dominate the market. At this point, there are those who think that the Fed should move beyond the standardized expectation and start working on a more proactive 50 basis point increase. The Fed has not made increases by more than 25 basis points for 22 years, but we have seen that it has been very proactive in reducing interest rates, for example at the March 2020 interim meeting. Just as the shock rate cut was deemed necessary at the beginning of the Covid crisis to stimulate economic growth, now those who advocate aggressive rate hikes in the fight against inflation put forward such an argument.


Interest rate and balance sheet spectrum… We know that the Fed will advance the more aggressive tightening path to take control in the fight against inflation, not only by lowering the interest rate, but also by lowering the balance sheet. Even if we look at the event in terms of market reflection and communication, the 10-year yield, which rose to 1.88% with the expectation of aggressive tightening, are now in a cooling flattening and when the Fed brought forward its 25 basis point guidance on January 26, the issue priced by the bond market is no longer interest but balance sheet speculation. We'll see.


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Fed funding rate and balance sheet size/GDP… ​​Source: Bloomberg


Yield gap… Interest rates between countries are increasing. Because China has prioritized growth and is trying to facilitate the credit mechanism. That's why it cuts rates. The ECB will also likely not have the mobility to follow the Fed's rate hike. There is also the following phenomenon for US bonds; When the Fed stops buying and starts selling bonds, the bonds of foreign buyers, especially China, are important, which means that we will face a struggle over the trading balance in bonds, especially before the theoretical level that will be reached with 3 interest rate hikes.


Conclusion? The FOMC made the first return to the policy normalization path, so now the question becomes its speed. After underestimating the risks around inflation for most of the year, the FOMC took a decidedly hawkish turn at its past meeting. Just six weeks after the committee announced that initial purchases would begin to slow, it doubled the declining rate of asset purchases. Next week, the FOMC will reaffirm the current pace of contraction, leaving asset purchases on track, ending mid-March.

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