The U.S. Federal Reserve has raised interest rates by 50 basis points, but ruled out larger rate hikes to curb inflationary pressures. Anthony Okolie speaks with Scott Colbourne, Managing Director, Active Fixed Income, TD Asset Management, about the implications for the U.S. economy.
- The Fed hiked rates 50 basis points today. And that's the biggest rate hike in 22 years. Now, that part was widely priced in by the markets. Scott, what stood out for you today?
- Hi, Tony. As expected, the Fed raised rates 50 basis points. As it guided the market to that magnitude of increase, it also announced the beginning of quantitative easing in June, next month. So those two were basically as expected. When you look at the press release, the Fed basically gave us very little room in terms of surprises.
They want to continue to raise rates. They acknowledge that there's a lot of inflationary pressures and risks out there, whether it's from the commodity shocks, the invasion in Ukraine. And there's still a tremendous amount of risk. So from my point of view, it was the-- press release, if you will, was pretty much down the fairway and basically guided us to more rate hikes down the road.
- Now, we also heard from a Jerome Powell. And he seemed to leave the door open for further half-point rate increases at the next couple of meetings. But it appeared that he poured cold water on a potential 75-basis-point hike. What's your take on those comments?
- Yeah, so this really highlights the difference between the press release, which we got at 2 o'clock-- and we waited around to 2:30-- and at the press conference. And exactly what you said-- honestly, when I first was listening to the reaction, Chairman Powell came out and said, inflation's too high, and the labor market is too tight. And my first reaction at 2:30 was, boy, that's hawkish.
And then as the questions went along, to your point, they dialed back the 75. And they basically said, look, it's really not on the table. There's a series of 50-basis point increases to be expected. And so that, in a nutshell, is really the market's taking it relative to the hawkish expectations going in. It's slightly dovish.
And I'm a little bit surprised, quite honestly, because at this point in time, where inflation is a risk, and they've really, really highlighted it, that the central bank is basically walking back some of its optionality. So net net, it was a little bit of a surprise for me that they sort of put that away as an option, that 75-basis-point rate hike. And the market is taking it slightly dovish here.
Two-year yields are rallying. Obviously equity markets are up. The dollar is a little weaker. So net net, that part caught me as a surprise.
- I think another thing that the markets were looking ahead to or investors were looking ahead to is the Fed also announced plans to start unwinding its $9 trillion balance sheet in June, which will ramp up over time. Any surprises here for you?
- No, I mean, we just got a little bit more details. They're starting next month with $30 billion in treasuries and $17 and 1/2 billion on the mortgage-backed securities side. The cap is 65 and 30, which they intend to get to by August. So honestly, that part was a bit of a nonimpact to the market. But it is going to be contributing to the broad drain and liquidity backdrop, which is reinforcing the rate hikes in the market.
- And beyond inflation, as well as the Russia-Ukraine conflict, what do you think are the biggest risks right now for the Fed's path on rates?
- I think the Fed talked about a soft landing, or softish landing. And that was also sort of slightly dovish to the market. And I think the risk here is obviously more of a harder landing, whether it's driven by developments in Europe perhaps or China perhaps. But certainly the US economy is slowing.
As we speak, the high-frequency data is showing evidence that it's slowing down. So there's a bit of a concern on the growth side and whether we move from softer landings to something more impactful. That is definitely a risk here.
But I think at the end of the day, the uncertainty band is very, very high on where we go and the outlook for inflation. And certainly we are concerned about the trajectory of inflation. And if it stays sticky and continues to go and not come down, the Fed will be resolved to stick with it and tighten more than expected.
- Finally, I want to talk a little bit about the US dollar, where the US dollar index has been on quite a roll lately. It's been outperforming. It's been trading at 20-year highs against a basket of currencies. Where do you see the US dollar going in the next little while?
- Well, as you noted, we've had a heck of a rally to the extent that perhaps there's a pause in the hawkishness in the market. We'll see some consolidation in the US dollar, maybe a bit of a sell off. But to the extent that we have further growth surprises, the US dollar will resume its rally, particularly against cyclical or commodity sensitive currencies.
There's certainly a divergence in monetary policy globally, so Europe and Japan in particular. So that's reinforcing US dollar strength. But from a short-term lens, given what I've heard today, we have scope here to see commodity currencies like Aussie and Canada rally and the US dollar pause for the time being.
- Scott, thank you very much for joining us.
- Thanks, Anthony.