The biggest question on monetary policy is how close the Fed is to ending its tightening cycle. While bullish investors may want the Fed to stop pressing on the breaks, which is the analogy for raising rates, usually after the hike cycle ends there is a recession. That’s a situation where the bulls need to be careful what they wish for. Some think inflation is low enough for the Fed to slow down its hike cycle and others think rising wage growth necessitates even more rate hikes.
As you can see from the chart below, the cumulative tightening in the effective Fed funds rate is much smaller in this cycle than in previous hike cycles.
Source: SG Cross Asset Research/Equity Quant
If you add the attribution of the suspension of QE and the recent unwind of the balance sheet, this hike cycle has a similar magnitude to the last few hike cycles. It’s questionable if QE can be calculated in this way because some view QE as an asset swap which doesn’t affect markets. The Fed seems to have wanted markets to believe QE was helping when it was in place, but then the Fed downplayed its effects after it ended. The yield curve tells us when the Fed will stop its hike cycle. Since the difference between the 10-year yield and 2-year yield is 26 basis points, the hike cycle might be close to ending.
Fed Makeup
The Fed is often thought of as a uniform body that always agrees with the Fed chair, but that’s incorrect. The chair doesn’t always get his or her way and the voting members are shuffled each year although some stay the same. The table below shows the changes to the FOMC voters in 2019 and 2020.
Source: ABN AMRO Group Economics
As you can see, one hawk drops out in 2019 (one less member with yellow shading) and one dove is added in 2020 (one more member with green shading). That means the Fed could be more dovish in the future. If only predicting Fed decisions was this easy. Sometimes voters such as Kashkari fluctuate between being hawkish and dovish. There’s a dispersion in the current dot plot for 2019 as 4 think rates should be 3.375%, 4 think rates should be 3.125%, and 4 think rates should be 2.875%. 3 others think rates should be lower. Economic data and the Fed fund futures will determine policy.
