The Board of Governors of the Federal Reserve raised interest rates by 50 basis points on Wednesday, and announced plans to initiate its quantitative tightening program, staying true to comments that have been more hawkish than in previous months.
The Federal Open Market Committee voted to maintain the federal funds rate in a target range of 0.75% to 1%. The central bank also announced that it would begin its anticipated quantitative tightening (QT) program, as expected, in earnest on June 1, the central bank said in a Wednesday statement.
“Right now the Fed seems intent on “front loading” of the removal of accommodations,” John Bellows, a portfolio manager at Pasadena, Calif.-based Western Asset Management Co., said during a recent webinar, “Macro Volatility and Today’s Credit Markets.”
“This is clearly a big shift from where they were at the end of 2021 and even earlier this year,” Bellows said, noting that Wednesday’s 50 basis point increase falls in line with signals of further tightening that the Fed has been telegraphing to the market in recent weeks. “They are quite hawkish. This is a little bit faster than what they had last time.”
As for the QT program, Bellows noted that while the central might shed as much as $60 billion in Treasurys and $35 billion in mortgage-backed securities (MBS) per month in its current campaign—and those sound like large numbers—the QT program is actually not a very aggressive. The Federal Reserve does not plan to reinvest maturing securities, Bellows said.
If the balances of maturing securities are lower than those being capped, then the runoff pace might effectively be slower. The sharp rise in mortgage rates means that mortgages repay at slower rates. Mortgages are longer duration bonds, the slower repayment rates are not likely to meet caps where they were at the end of 2021, Bellow said.
“The pace of runoffs could be lower, because you have fewer maturing mortgages,” he said.
While Fed actions are certainly important, Bellows also noted that there is a strong argument that signaling as a way for balance sheet policy can affect capital markets and financial conditions. When the Federal Reserve wants to signal an easier monetary policy, they typically buy a lot of bonds.
In March 2020, for instance, the Federal Reserve committed to a $700 billion round of quantitative easing to help jumpstart a virtually comatose economy in the grip of the COVID-19 pandemic.
“Eighty billion dollars a month is a slower runoff than they had a run up,” Bellows said. “That is a strong signal to the industry, in terms of accommodation.”
While the Fed has made its intentions known, the market does not uniformly agree, Bellows noted.
“There is a broadly shared view that they should be removing accommodation,” he said. “There is not a consensus about where they should go next.”
