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The U.S. Fed keeps its key interest rate on hold near zero, but signals two interest rate increases by late 2023. Anthony Okolie speaks with Scott Colbourne, Managing Director, TD Asset Management, about the Fed’s policy shift and implications for markets.
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ANTHONY OKOLIE [00:00:03] As expected, the Federal Reserve left rates unchanged, but they said they plan to raise rates by late 2023. That's much sooner than they expected. Scott, what got your attention today?
SCOTT COLBOURNE [00:00:14] Hi, Tony. Yeah, the market was a little bit surprised. We had expected no change, as you acknowledged, on rates and purchase program and no real focus on taper talk. They did surprise us with changes to the dot plots. And so that is just a summary of the economic projections and the governor's forecasts for further out. And as you know, in 2023, we've got now a median forecast of two hikes in the Fed funds rate. That absolutely has surprised the markets. We were all going in with maybe an expectation of one hike in 2023. So you could characterize this as slightly more hawkish than the market was expected in terms of where the Fed is going on rates.
ANTHONY OKOLIE [00:01:04] Now, the Fed also raised their outlook for inflation and growth this year. Was this a surprise for the markets?
SCOTT COLBOURNE [00:01:10] Yeah, I mean, we expected the Fed to adjust the forecast. The last forecast was in March, the SEP and now we have the June Summary of Economic Projections. And so we expected the growth, inflation to be all adjusted higher. It was surprisingly higher for this year on both the growth and inflation side. And so that was in combination with the adjustment on the dot plots. As well we had small changes to administered rates in the front end of the market, the interest on excess reserves and the reverse repo program. So combine this all in a collective package and then throw in the previous announcement on selling their corporate bonds, the ETFs. I would say in aggregate, when you put it all together, this is definitely a change of narrative, a change of bias by the Fed. They're definitely transitioning the market to a slightly higher interest rate regime and a more hawkish regime from the Fed.
ANTHONY OKOLIE [00:02:18] There wasn't much talk about tapering from the Fed today, but do you see that happening down the road?
SCOTT COLBOURNE [00:02:23] Yeah, it's been a focus of the market. When do we begin to talk about tapering? And the Fed did acknowledge today, or Jay Powell in his press conference, did acknowledge that they're looking at what are the conditions that might lead to further discussions on tapering. So this is an inevitability. We know that over the next six months, the Fed will be begin announcing the end of the quantitative easing program. So it's a question of when the announcement takes place. The markets are focusing on perhaps September as the key point with the actual tapering either taking place in the December meeting or early in the first quarter of 2022. So this is an inevitability that we're going to discuss that, in combined with all the slightly more hawkish signals that we got from the Fed today, leads us to believe that the Fed is setting the conditions for the market to begin this discussion.
ANTHONY OKOLIE [00:03:26] And talk to us about the US dollar. We did see a bit of strengthening from the greenback just after the announcement. Where do you see the US dollar going over the next little while?
SCOTT COLBOURNE [00:03:37] Now, when you look back, you know, since the beginning of the year, the US dollar is slightly weaker on a broad basis. And what's been a key driver of this is real yields, particularly real yields in the US. And up until today, the more hawkish central banks like the Bank of Canada and Norway were outperforming. But what we saw today is a big sell off, actually, in the short end, real yields in the US and that will be supportive of the US dollar. So I think the US dollar, weak trade, for the time being, has run its course. And so it'll be a lot more nuanced, depending on which country you're dealing with and the stance of the central banks. But I'm not in the camp anymore of a weak US dollar, given where the adjustments are by Fed policy, starting with today's adjustments on the dot plots.
ANTHONY OKOLIE [00:04:30] Scott, thank you very much for your insights.
SCOTT COLBOURNE [00:04:33] My pleasure, Tony.
SCOTT COLBOURNE [00:00:14] Hi, Tony. Yeah, the market was a little bit surprised. We had expected no change, as you acknowledged, on rates and purchase program and no real focus on taper talk. They did surprise us with changes to the dot plots. And so that is just a summary of the economic projections and the governor's forecasts for further out. And as you know, in 2023, we've got now a median forecast of two hikes in the Fed funds rate. That absolutely has surprised the markets. We were all going in with maybe an expectation of one hike in 2023. So you could characterize this as slightly more hawkish than the market was expected in terms of where the Fed is going on rates.
ANTHONY OKOLIE [00:01:04] Now, the Fed also raised their outlook for inflation and growth this year. Was this a surprise for the markets?
SCOTT COLBOURNE [00:01:10] Yeah, I mean, we expected the Fed to adjust the forecast. The last forecast was in March, the SEP and now we have the June Summary of Economic Projections. And so we expected the growth, inflation to be all adjusted higher. It was surprisingly higher for this year on both the growth and inflation side. And so that was in combination with the adjustment on the dot plots. As well we had small changes to administered rates in the front end of the market, the interest on excess reserves and the reverse repo program. So combine this all in a collective package and then throw in the previous announcement on selling their corporate bonds, the ETFs. I would say in aggregate, when you put it all together, this is definitely a change of narrative, a change of bias by the Fed. They're definitely transitioning the market to a slightly higher interest rate regime and a more hawkish regime from the Fed.
ANTHONY OKOLIE [00:02:18] There wasn't much talk about tapering from the Fed today, but do you see that happening down the road?
SCOTT COLBOURNE [00:02:23] Yeah, it's been a focus of the market. When do we begin to talk about tapering? And the Fed did acknowledge today, or Jay Powell in his press conference, did acknowledge that they're looking at what are the conditions that might lead to further discussions on tapering. So this is an inevitability. We know that over the next six months, the Fed will be begin announcing the end of the quantitative easing program. So it's a question of when the announcement takes place. The markets are focusing on perhaps September as the key point with the actual tapering either taking place in the December meeting or early in the first quarter of 2022. So this is an inevitability that we're going to discuss that, in combined with all the slightly more hawkish signals that we got from the Fed today, leads us to believe that the Fed is setting the conditions for the market to begin this discussion.
ANTHONY OKOLIE [00:03:26] And talk to us about the US dollar. We did see a bit of strengthening from the greenback just after the announcement. Where do you see the US dollar going over the next little while?
SCOTT COLBOURNE [00:03:37] Now, when you look back, you know, since the beginning of the year, the US dollar is slightly weaker on a broad basis. And what's been a key driver of this is real yields, particularly real yields in the US. And up until today, the more hawkish central banks like the Bank of Canada and Norway were outperforming. But what we saw today is a big sell off, actually, in the short end, real yields in the US and that will be supportive of the US dollar. So I think the US dollar, weak trade, for the time being, has run its course. And so it'll be a lot more nuanced, depending on which country you're dealing with and the stance of the central banks. But I'm not in the camp anymore of a weak US dollar, given where the adjustments are by Fed policy, starting with today's adjustments on the dot plots.
ANTHONY OKOLIE [00:04:30] Scott, thank you very much for your insights.
SCOTT COLBOURNE [00:04:33] My pleasure, Tony.
