In advance of the next Federal Open Market Committee (FOMC) meeting on May 3-4, 2022, the markets are anticipating that it will decide to increase the federal funds rate by 50 basis points (bp), raising the target range from the current 25-50 bp to 75-100 bp. This mirrors comments made by Federal Reserve Board (FRB) Chair Jerome Powell during a seminar sponsored by the International Monetary Fund (IMF) on April 21, 2022. He said that an interest rate hike of "50 basis points will be on the table for the May meeting."
Additionally, the FOMC is likely to begin reducing its balance sheet "considerably more rapidly than in the previous recovery," as Federal Reserve Governor Lael Brainard stated in a speech on April 5, 2022. "It is of paramount importance to get inflation down," she said.
- The Fed is likely to raise the federal funds rate by 50 basis points (bp) at its May 3-4, 2022 meeting.
- More rate hikes are expected to follow, with the goal of reducing inflation.
- The markets anticipate that the federal funds rate will exceed 3% by early 2023.
- Rapid reduction of the Fed's $8.9 trillion balance sheet is a related agenda item.
- At the FOMC's last meeting, in March, trimming the balance sheet by $95 billion per month had general support.
Getting Inflation Down
During the IMF panel discussion, Powell insisted that "getting inflation back to the 2% goal" is a critical policy imperative right now. He noted that it is "absolutely essential to get price stability" as a means to achieve both labor market stability and overall economic stability.
Powell added, "Our goal is to use our tools to get demand and supply back in sync, without a recession." Meanwhile, he noted that one or more rate increases of 50 bp each are favored by several FOMC members, but he would not disclose his own position.
Shrinking the Fed's Balance Sheet
In her speech, Brainard indicated that the last period of balance sheet reduction was in 2017-19. During this time, the Fed reduced it by about $50 billion per month. According to the minutes of the last FOMC meeting, which was held on March 15-16, 2022, members generally favored setting the initial rate of balance sheet reduction at roughly double that rate, or about $95 billion per month.
Indeed, all the options presented by Federal Reserve staff for balance sheet reduction at that meeting involved a more rapid balance sheet "runoff" than what was implemented in 2017-19. Additionally, all participants agreed that the combination of high inflation and a tight labor market call for a faster pace of runoff than in 2017-19.
As points of reference, the size of the Fed's balance sheet was a record $8.9 trillion as of the week starting April 25, 2022. This is more than double the range of around $4.4 trillion that existed from mid-2014 to early 2018, and it is also up significantly from a recent low of about $3.8 trillion in mid-2019.
The Effective Federal Funds Rate
At its meeting on March 15-16, 2022, the FOMC voted to raise the target range of the federal funds rate by 25 bp, from 0-25 bp to 25-50 bp. The effective federal funds rate (EFFR), the volume-weighted median of overnight federal funds transactions, has been near the lower end of those ranges. Through March 16, it was at 8 bp. From March 17 onwards, it has been at 33 bp, precisely 25 bp higher than before.
What the Markets Forecast
The CME FedWatch Tool and the Atlanta Fed Market Probability Tracker are based on complex analyses of securities whose pricing is driven by expectations about interest rates in general and FOMC policy moves in particular. Both assign ranges of probabilities to decisions about the federal funds rate at future FOMC meetings.
CME FedWatch Tool 2022 Projections
On the morning of May 2, 2022, the CME FedWatch Tool anticipated this pattern of future rate hikes coming out of the remaining FOMC meetings currently scheduled for 2022:
- May: 50 bp increase to a new target range of 75-100 bp
- June: 75 bp increase to a new target range of 150-175 bp
- July: 50 bp increase to a new target range of 200-225 bp
- September: roughly equal odds for a new target range of 225-250 bp or 250-275 bp
- November: roughly equal odds for a new target range of 250-275 bp or 275-300 bp
- December: roughly equal odds for a new target range of 275-300 bp or 300-325 bp
Atlanta Fed Market Probability Tracker 2022 Projections
Meanwhile, the Market Probability Tracker from the Federal Reserve Bank of Atlanta projects that the most likely path of the three-month average federal funds rate, currently at 33 bp, would be:
- May and June: up a cumulative 130 bp to 163 bp
- July through September: up a cumulative 77 bp to 240 bp
- November and December: up a cumulative 43 bp to 283 bp
Projections For 2023
Looking farther ahead, the CME FedWatch Tool anticipates that the target range most likely will be 350-375 bp by July 2023. The Atlanta Fed Market Probability Tracker anticipates a three-month average federal funds rate of 322 bp by that time.