The Fed will raise the fed funds rate by 50 basis points and announce the balance sheet runoff next week, as markets expected and as Powell signaled ahead of the blackout week. The post-meeting announcement could point to a future rate of increase that could adjust expectations for the Treasury yield curve. Several FOMC respondents implied recently that the committee was committed to rapidly rising to the neutral rate, which the median respondent currently estimates is 2.4%. With the rapid slowdown of the global economy and the sharp tightening of financial conditions, the next policy path is uncertain.

 

A 50 basis point rate hike at the Fed's May meeting has already been assumed since Powell openly said he would be on the table. Now the latest wage data is prompting markets to consider another 75 basis point tightening in June. We see the terminal data slowly starting to adjust pricing in terms of 75bps rate hikes in June and July, and the next path will be assumed as Powell adds fire or water to these expectations. We will pay attention to guidance on how the runoff of balance sheet reductions will affect the economy, as well as the size of future rate hikes.

 

Fed future funds interest rate projections… Source: Bloomberg, CME Fedwatch

 

The challenge Powell will face at the post-meeting press conference will be to provide greater clarity on how the committee views headwinds from abroad, from a sharp Chinese slowdown to a possible European recession. Considering the early signs that US inflation has reached its peak, there may be reservations that the 75 bps rate hike could have extreme effects. We think that this is not the case for May, and it would be more ideal to keep the scale at 50 bps and present a detailed plan to shrink the Fed's balance sheet.

 

As a result; In terms of interest rate policy, there does not seem to be any opposition to the 50 bps increase on May 4th. The smoothest expectation is here. On balance sheet, the FOMC will likely announce the start date of normalization and provide details on the cap. The initial cap is expected to be $35 billion ($20 billion for UST and $15 billion for MBS), increasing to $95 billion per month ($60 billion for UST, $35 billion for MBS) over a three-month phase. Powell will likely be asked in June about the possibility of a 75 basis point increase. Given the uncertain inflation outlook, it probably won't close this option, but it will also avoid sharp guidance. However, he will likely say that the committee is aiming to raise interest rates "methodically" to neutral.

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