The Fed minutes clarified that the Fed would commence the process of winding down its $9 trillion balance sheet. The actual approval for the winding down will be taken at the next FOMC meet on May 03-04. The monthly winding down would be something like this.
| Monthly Winding Down | Treasuries | Mortgage Backed Securities | Total Monthly Unwind |
| Starting from May-22 | $60 billion | $35 billion | $95 billion |
The above amounts would be the caps and these will be open to modifications based on market conditions. However, this average monthly unwinding would be nearly twice the unwinding done in the last round in 2017-19, when it was $50 billion a month.
CME Fedwatch shows more certainty of early rate hikes
One indicator of the probability of rate hike and its timing is CME Fedwatch. Here are the implied probabilities of different Fed rate scenarios over the next 7 Fed meetings.
| Fed Meet | 50-75 | 75-100 | 100-125 | 125-150 | 150-175 | 175-200 | 200-225 | 225-250 | 250-275 | 275-300 | 300-325 |
| May-22 | 21.2% | 78.8% | Nil | Nil | Nil | Nil | Nil | Nil | Nil | Nil | Nil |
| Jun-22 | Nil | Nil | 14.5% | 60.7% | 24.8% | Nil | Nil | Nil | Nil | Nil | Nil |
| Jul-22 | Nil | Nil | Nil | 5.7% | 32.8% | 47.2% | 14.3% | Nil | Nil | Nil | Nil |
| Sep-22 | Nil | Nil | Nil | Nil | 4.0% | 24.5% | 42.5% | 24.5% | 4.5% | Nil | Nil |
| Nov-22 | Nil | Nil | Nil | Nil | Nil | 3.6% | 22.8% | 40.9% | 26.1% | 6.2% | 0.4% |
| Dec-22 | Nil | Nil | Nil | Nil | Nil | Nil | 3.5% | 22.3% | 40.5% | 26.5 | 7.2% |
| Feb-23 | Nil | Nil | Nil | Nil | Nil | Nil | 1.0% | 9.0% | 28.3% | 37.2% | 24.6% |
Data source: CME Fedwatch
Normally a probability in the range of 25% to 30% is a strong indication of affirmative action.
As the Fed has spoken in hawkish tones, the CME Fedwatch (an indicator of Fed Futures trading) is hinting at market view being most hawkish in recent memory.
What we gather from the minutes of the Mar-22 FOMC meet
The Mar-22 FOMC meet was explicit about 6 additional rate hikes in 2022. Now, the minutes make 2 more things clear. Firstly, hawkish action by the Fed would be more intense than the hawkish statements. Secondly, the Fed will look to magnify the impact of the rate hikes by synchronizing with the bond book unwinding.
a) The outer trajectory of peak interest rates, pegged at around 2.75%, has now been unofficially raised to 3.25%. The markets see Fed being more hawkish than anticipated to curb consumer inflation; still rampant at 7.9% in Feb-22.
b) The minutes indicate that most members of the FOMC were inclined towards a 50 bps rate hike in March but refrained due to the Ukraine situation. However, the market consensus now appears to be of 50 bps rate hike May 2022.
c) The Fed is also expected to raise the pace of rate hikes with; possibly multiple 50 bps rate hikes with targeted interest rates around 2.75% by Dec-22. That could have strong ramifications for other economies in terms of monetary divergence.
d) Fed proposes to magnify the impact of rate hikes by combining it with unwinding of the bond book at the rate of $95 billion per month. The bond book had doubled to $9 trillion amidst liquidity infusion during the COVID-driven economic slowdown.
e) While the Fed had already dropped the word “Transitory” to describe consumer inflation about 4 months back, the minutes of the Mar-22 FOMC meet make it amply clear that the entire focus of the Fed in the short term would be towards fighting inflation.
f) The Fed minutes refer to a few jumbo rate hikes of 50 bps each in the current year, which is necessitated due to the Fed being way behind the curve on rate hikes. With inflation at 7.9%, the real bond yields are deeply in the negative zone.
g) According to the Fed minutes, the first target for the Fed would be to move to a neutral Fed rate of 2.40%; nearly 200 bps higher from current levels. It is only at this level that the Fed would even rethink its strategy and this move could happen rapidly.
h) The one factor that could circumscribe bond book unwinding decision is the inversion of the US yield curve. The 2 year yields went above 10-year bond yields; a signal of negative GDP impact of rate hikes at the longer end. It is not yet clear how the Fed reacts to this economic data point.
Mar-22 Fed minutes could be a call to action for India
There are 3 key takeaways for India from the Mar-22 Fed minutes.
For now, the focus shifts on the RBI monetary policy on 08th April.
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