Andrew Pyle
March 18, 2022
So much for being behind the curve
As 2021 rolled on, there was increasing criticism of the US Federal Reserve for not taking a tougher stand on inflation, which was looking like a runaway train by year-end. Those commentaries continued right through into this week, when it held its second policy meeting of 2022. You will recall back in January, that Ally and I held firm to our view that the Fed would likely increase rates 3 or 4 times this year, even while market participants were clamoring over themselves in anticipation of double this amount of tightening. Speculation turned to a potential half a percent increase at the March meeting – a call that we also voted against. As it turned out, the Fed delivered a quarter-point increase in its overnight target rate and, given the rally in stocks after the meeting, it would appear that there isn’t a lot of criticism anymore about being behind the curve.
To be honest, the probability that the Chair Powell and the gang would hike rates by half a point on the first move was extremely low and flies against historical patterns. Even if the Fed were to lift rates four consecutive times, each by a quarter of a point, this would still be faster than most previous tightening cycles. To illustrate, let’s assume that the Fed does raise rates at its next three meetings (May 4th, June 15th and July 27th). Its overnight rate target would then be at 1% and taken 129 days to get there. After it started raising rates at the end of 2015, it took over 540 days to get the same cumulative tightening. In fact, we have to go back to 2004, when it took the same 129 days for the Fed to move a full percentage point.
The fastest liftoffs were in the 1980s. After starting to raise rates in the Spring of 1984, it only took about 80 days to add a percentage point in tightening. A decade later, it was only about 100 days before a full point was initially added. Both of these episodes contained single rate hikes of half a percent, and three-quarters of a point. The last time we saw the Fed move by half a point in a single meeting was in May 2000, which is why the call for such a decision this week carried such low odds.
As important as the actual decision this week was, there was a greater focus on the Q&A session that followed the announcement, since this is where any future guidance will come out. Not surprisingly, that guidance is a little mixed in the wake of the Ukraine conflict. Powell himself commented that the US economy is set to “flourish”, even in the face of tighter monetary conditions; but current economic activity is hard to decipher. Many of you will remember a couple of years ago, when Ally and I would talk about an indicator called the Citi Economic Surprise Index. This basically looks at economic data reports and compares the outcomes to expectations going into the reports. The higher the index, the more the numbers are beating street estimates and vice versa.
The index had fallen back into negative territory last September, in the wake of the Delta variant wave, but recovered into December. The threat of rising inflation and higher interest rates impacted activity and US data started to surprise on the downside again. Since the start of February, however, we have seen a ton of reports that have come in ahead of street expectations and, last week, the index reached its best level in a year.
We have to keep in mind that the economic reports are themselves snapshots of the past and, therefore, so is the surprise index. The uncertainty created by Russia’s invasion of Ukraine and the spike in commodity prices suggests the economic figures for the month of March could show weakness. We won’t see these until next month at the earliest, but the Fed is already building some hedging language into its remarks.
The other important consideration for the Fed is the duration of the conflict in Ukraine. Reports this week have been back and forth in terms of a path to resolution, either from diplomacy or simply because of the weariness of Russia’s military and economy. The market is sensing a possible resolution too, and we are seeing this play out in some commodities (oil prices bounced on Thursday but are still well below the peak reached last week). If some semblance of peace is reachable, then the economic uncertainty fades and economies can return to the trajectories prior to the conflict.
In terms of Fed policy, Ally and I still believe this leaves us right where we thought we would be in the second quarter. Unless we get another negative shock to demand, the stage could be set for a second Fed rate hike in May. The Bank of Canada will be meeting a few weeks before then (April 13th) and we expect a similar second move by the Bank. The tandem adjustments to rates between the two central banks should keep us in a relative tight range for the Canadian dollar, which was able to tick back above 79 US cents this week on the rebound in crude oil. The fact that $120 oil couldn’t get the Loonie back to 80 cents suggests to us that the risk is to the downside, unless the Bank decides it wants to be the first to raise rates half a point next month. I think the Fed has shown Ottawa that you can defy the critics and those telling you to be more aggressive and still get a favourable response.
On behalf of the Pyle Group, have a wonderful weekend. Next Tuesday, we will be hosting our monthly conference call. Call-in details are listed below.
Andrew
Pyle Group Conference Call
Tuesday March 22, 2020
Participants:
Toll-free dial-in number (Canada/US): 1-800-806-5484
Local dial-in number: 416-340-2217
Participant passcode: 4127912#
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