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Introduction to FOMC guidance

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Faster tapering… Economic actors, especially US companies, are faced with the fastest rising cost inflation in decades. Producer prices have increased by 9.7% as of the end of 2021, while consumer inflation is at 7%, the highest level in 40 years. 10-year Treasury bond yields, which are considered as borrowing costs for the private sector, are at 1.83%. Yields on 2-year Treasuries are at 1.03%, the highest level since February 2020. Markets predict that the Central Bank will increase interest rates for the first time this year with a 92% probability in March.

 

Comparison of US 2-year and 10-year Treasury bond yields with Germany and UK 10-year bond yields Source: Bloomberg

 

Rate hike and adverse wind possibilities… The FOMC started to reduce its asset purchases more rapidly as of December and will end it completely in March. After this stage, theoretically, there is a possibility of increasing interest rates at every meeting. Unless a headwind blows, rate hikes this year are likely to move more proactively than the path envisioned in the December FOMC projections. This means that there may be more than 3 rate hikes this year. We have several notable data developments that are the subject of this proactivity. The perspective gained by the inflation background provides the transition to a more strict policy ground within the framework of the disturbing price pressures being felt in the foreground. FOMC members are concerned that the strongest inflation decline in a generation will likely take longer than previously thought. In Powell’s speech to Congress, we see the phrase “it seems that the factors pushing inflation will continue until next year” and the removal of the phrase “temporary” from the literature as groundbreaking movements at this point.

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The labor market also took meaningful steps towards full employment in the inter-meeting period. Although headline employment growth has been insufficient in the last two data, the progress in the labor force continues and at the same time the multidimensional dynamics of the labor market pave the way for further inflation. The unemployment rate has advanced to the best levels of the post-Covid era. While there is still room for improvement in the jobs picture, the clearly tighter labor market eases tensions between the FOMC’s price stability and employment targets.

 

US and China producer and consumer inflation rates… Source: Bloomberg

 

Conclusion? December projections showed that 2022 and 2023 will be passed with 3 rate hikes each. It is likely that these scales will be exceeded, because the developments after the December meeting increased the suspicions about a possible permanent inflation dynamic. The cumulative number of increases projections show the federal funds rate at the 2.5% band at the end of 2024. In terms of controlling short-term interest rates, we monitor the Fed’s transition to neutral rates.

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