The US Federal Reserve’s interest rate decision, which markets are focusing on, will be announced tomorrow. So what are the expectations for interest rates? How will markets be affected if interest rates rise? Here is the answer…
THE FED’S KEY POINTS…
Economist Enver Erkan, who has made statements on the subject, used the following expressions: “While the main points of the Fed’s decision on Wednesday will be rate hikes of 75 basis points or 100 basis points , the main point will be the terminal rate assumption and the content of the balance sheet rather than the speed of interest rate hikes.It is also important to know when the Fed, which started the QT trend on paper by reducing its balance sheet from June 1, will switch to active balance sheet sales or whether it will make such an adjustment strategy in order to increase the effects of the tightening.
SALES IN REAL ECONOMY
The prospect of a 100 basis point rate hike will likely be less probed by the Fed at this time. Because the possibility of an overly active Fed driving terminal rates to unsustainable levels will make it appear that the risk of recession is also underestimated in the economy. The Fed tightened late by misinterpreting the risk of inflation, now it is tightening too much by misinterpreting the risk of recession. In the context of 75 bps, 80% swap pricing in July, this seems more reasonable under the following conditions. In an environment where economic activity is slowing faster than expected and where pressure is mounting, pushing the band of uncertainty too far risks further deteriorating the relevant indicators.
The ECB raised interest rates by 50 basis points, but it is technically not possible to maintain increases at the highest level due to recession risks. From financing risks to the real risks of the sector, uncertainty will aggravate the stagnation of activity in many branches. For the Fed, the situation is as follows; Although the analyzes show that the American economy has a low potential to be affected by the energy crisis and that the job market is solid, they show that the difficulties of production and supply of the United States on the foreign markets cannot be avoided without slowing down. We can add to this the possibility of slowing down investment and employment by considering the uncertainties on the financing conditions of companies and the real economy.
BALANCE SHEET STRATEGY
Beginning June 1, the Fed began to reduce its balance sheet by $9 trillion to mobilize liquidity. The central bank has purchased about $4.6 trillion of Treasuries and mortgage-backed securities through quantitative easing over the past two years to hold down longer-term interest rates. . The process, also known as QE, led to an increase in bank reserves.
When Treasury securities held by the Fed mature, the Fed holds fewer assets (Treasuries decline) and has fewer liabilities when the Fed does not reinvest the proceeds of matured securities and the Treasury does not issue no new titles. At the end of this period, the size of the Fed’s balance sheet will shrink as Treasuries decline on the asset side and reserves on the liability side. It is possible that the Fed will accelerate this pace of contraction by emptying the MBS portfolio more quickly.
In this price environment, a rise of 75 bps will have an FOMC effect which will not create a variable effect of surprise, and a rise of 100 bps will have a hawkish FOMC effect. If the market moves towards a view of the Fed ignoring a recession for inflation, the asymmetry in the yield curve will worsen. In such an environment, 2-year interest rates are more likely to continue to rise than 10-year ones. Keep in mind that even as it stands, the Fed is on course for the biggest tightening since the Volcker era. Inflation remains the most important concern for policymakers, attention will need to be paid to the details of the gradual situation on the growth outlook and the pace of interest rates.
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