It comes as no surprise to us as we have warned about this since December of last year. Fed has just announced a 25 basis points increase on its federal funds rate to move it to a range of between 0.25-0.50%.
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Russia’s invasion of Ukraine on 24 February has thrown a spanner in the works for Fed officials bent on a tightening path this year. Concern has grown in recent weeks of stagflation risks where slowing growth due to the war is met with escalating prices. This is exactly what the Fed is forecasting now for the U.S. economy with downward revision to GDP growth from 4% to 2.8% for 2022 but sharp upward increases to inflation (core PCE index) ending the year at 4.1%, from 2.7% previously forecasted. It expects unemployment to remain at 3.5% by end 2022.
The stock market rallied as the Fed statement is exactly what it wants to hear – turning up its hawkish tone by a few notches. Going by the dot plots, the committee has increased its projection by a full percentage point of where it sees the fund rates will end 2022 at – from 0.9% in its December FOMC to 1.9%! There are only six more FOMC meetings scheduled for the year in May, June, July, September, November & December. Effectively it means Fed has now pencilled in a 0.25% hike in every one of those meetings to bring fed funds to a range of 1.75%-2.00%. Furthermore, the committee now forecast four more rate hikes in 2023 to bring the funds rate to 2.8%, going above the long run neutral rate of 2.4-2.5%.
Going by our interest rate cycle chart, the last time fed funds hit 2%, 3-month SIBOR in Singapore went to 1.70% and 3-month compounded SORA reached 1.30%. That should give a fairly good gauge of where interest rate in Singapore is heading by end of the year. The question is – will Fed go all the way with a total of seven hikes this year?
Certainly, that will mark the fastest rate increase within the span of 12 months, in the last 40 years of Fed’s history. This is what we have warned in our last article. Put it another way – it’s almost double the pace of a typical tightening cycle of four rate hikes or 1% increase in a year. Fed now seeks to hike seven times from 0.25% to 2% within the space of one year?
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Going by our interest rate cycle chart, the last time fed funds hit 2%, 3-month SIBOR in Singapore went to 1.70% and 3-month compounded SORA reached 1.30%. That should give a fairly good gauge of where interest rate in Singapore is heading by end of the year.Certainly, that will mark the fastest rate increase within the span of 12 months, in the last 40 years of Fed’s history.
We caution reading too literally into Fed statement. Remember Fed is data-dependant, and data might change over the course of the next few months depending on how protracted is the war, and if we are going to get any more VOC (variant of concern) in the pandemic. I think inadvertently Fed has just set itself up for a higher risk of causing a recession in 2023, with the possible need to go overdrive on rate hikes in 2H of the year. Why so? Let me explain.
The vote for 0.25% hike in this FOMC was 9 to 1, with the only dissent coming from the vocal St. Louis Fed President Jim Bullard who argues for 0.50%. I am somewhat on the same page as Bullard as I think Fed should have erred on the side of “front-loading” more at the start instead of inching up with mere 0.25%, notwithstanding the war. The rationale is simple to follow. Fed was already late in the cycle with inflation data set to become worse next month. They are not meeting again until May and any effect of rate hike will need time to trickle down to the broad economy. A quarter point hike now is unlikely to have any effect which means they’d just wasted three more months doing nothing. All that with escalating oil and commodity prices, and a supply chain situation that is set to get worse with China battling its most challenging Omicron outbreak. Doing too much with 0.50% hike now, coming from a low base, can easily be reversed or paused in 2H; but doing too little means Fed might really need to “slam on the brakes” hard should inflation run out of control. I hope I am wrong here, or we might see more than seven rate increases this year with some 0.50% hikes built-in. Especially if the war turns out to be short-lived. No one knows.
For those with home loan lock-in expiring this year, speak to us and refinance quickly now as there are just that few banks left with fixed rate mortgages below 1.50% right now, but not for very much longer.
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