In light of inflation remaining above 2.0% and strong labour market, the FOMC indicated it will start raising rates in March and end the tapering process in the same month. FOMC chair Powell hinted that inflation could be more persistent than previously expected which could lead to more aggressive rate hikes.
The FOMC Maintained the Interest Rate at 0-0.25%.
On economic outlook, the FOMC assessed indicators of economic activity and employment have continued to strengthen. The sectors most affected by the pandemic have improved in recent months, but are being affected by the sharp rise in COVID-19 cases. The Fed judged job gains have been solid in recent months, and the unemployment rate has declined substantially while supply and demand imbalances related to the pandemic and the reopening of the economy continued to contribute to elevated levels of inflation. The FOMC reiterated that the path of the economy will depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in employment as well as reduction in inflation while risks to the outlook remained, including from new variants of the virus.
In this meeting, the Fed judged that inflation is well above 2% and strong labour market, the Committee expected it will soon be appropriate to raise the target range, for the federal funds rate. In addition, the Fed will continue to reduce the monthly purchase of its net asset purchases, bringing them to end in early March. Beginning in February, the Committee will increase its Treasury holdings by at least USD20bn per month and USD10bn (previous: USD5bn) for agency mortgage-backed securities.
The Fed expects real GDP to moderate to 4.0% YoY (2021: +5.5% YoY) in 2022 and 2.2% in 2023. On unemployment rate, the Fed’s forecast is tighter at 3.5% (2021: 4.3%) in 2022 and 3.5% in 2023. On inflation, the Committee has projected inflation to remain above 2.0% at 2.6% YoY in 2022 (2021: 5.3% YoY) and 2.3% YoY in 2023. Core inflation is also anticipated to remain above 2.0% at 2.7% YoY (2021: 4.4% YoY) and ease slightly to 2.3% YoY in 2023. In 2022, all 18 FOMC members anticipate rate to increase, with majority forecasting it to increase by 75bps, implying 3 rate increases (25bps each). In 2023, all members anticipate rate to rise further, leading the median interest rate projection to increase in 2022 by 80bps and further 70bps in 2023.
All FOMC Policymakers Were in Favour of the Actions.
In today’s meeting, the FOMC acknowledged that while labour market has yet to fully recover to pre pandemic levels, the demand for workers is so much higher than supply that employment should remain ample even if demand for workers were to decelerate slightly in response to rate hikes. In response to strong labour market and high inflation, the Fed pointed to the first rate hike in the next meeting in March. However, FOMC chair declined to rule out raising rates at every meeting for the rest of the year, and did not give a clear road map on how to calibrate the policy thereafter, especially in terms of balance sheet reduction. This uncertainty could give rise to further financial market volatility especially in the face of ongoing Covid-19 pandemic with the more transmissible Omicron variant leading to continued mismatch between job openings and unemployed persons and geopolitical tensions which could extend inflationary pressures due to rise in commodity prices. As the Fed is expected to tighten monetary policy faster than Malaysia, we maintain our expectation of slight depreciation bias with average USD-MYR at 4.16 vs 4.15 average for 2021.
Source: Hong Leong Investment Bank Research - 27 Jan 2022