Fed preview: time for higher rates❗

Key highlights:

• The Fed is broadly expected to lift interest rate for the first time today
• Powell will suggest more tightening despite warrelated uncertainty
• The decision is at 6pm GMT, conference starts 30 minutes later
• We will provide LIVE coverage of the event in the “News” section

The decision

This is the “easy” part. The Fed communicated it so well that there are no doubts – interest rate will increase today by 25 basis points – the first post-pandemic rate increase. This has been long priced in by the markets and it’s not this decision that matter but what comes next.

Markets expect the Fed to increase rates at every meeting this year and see high odds of a “double” interest rate increase in May. Source: Bloomberg

What to watch for

The first thing to watch is the “dot-plot”, a chart where FOMC members reveal their expectations of future rates. In December they saw just 2 hikes for 2022, now the markets sees at least… 6! So the first question is, if the plot validates these expectations.

Second is balance sheet. There will be most likely no commitments today but during the conference president Powell will be asked about the starting point and the pace of balance sheet reduction. This is the opposite to the QE (“money printing”) that was so supportive for stocks so the sooner the reversal starts, the worse news this is for stock markets.  

Higher rates are one thing but balance sheet shrinkage could be more important for stocks – there is clearly a correlation between annual balance sheet changes of the top central banks (Fed, ECB, BoJ – green area) and global stocks performance (red line). Source: XTB Research

Key markets to watch

US100

The tech heavy index saw a major correction, mostly due to anticipated change in monetary policy. Tightening is negative but the market is oversold in the short run and the 13000 zone held up 3 times providing a basis for a possible short-term recovery – unless the Fed is very hawkish.

Gold

Gold prices have tested 2020 highs recently but are in a reversal as war-related fears abate somewhat. Here the rule is simple – the more hawkish Fed, the worse it is for Gold prices.

EURUSD

The pair remains in a strong downward trend and since the war is more negative for the euro in relative terms, this trend has gained even more traction. Hawkish Fed means stronger dollar but remember that market expectations are already high.

BOTTOM LINE: we expect the Fed to raise rates by 25 basis points. Expectations regarding future rate hikes are already high so the meeting must not be a “negative event” for the markets. However, future balance sheet shrinkage remains the biggest risk for stocks in 2022.