Investors can breathe a sigh of relief as Maybank Kim Eng’s research team anticipates no changes to interest rates at the upcoming Federal Open Market Committee meeting on June 15 to 16. Despite inflation jitters, Fed fund rates are seen to remain at 0.00-0.25%, while the pace of asset purchases will likely be maintained at US$120 billion ($158.4 billion) per month. 

But growing murmurs about a rate hike within the FOMC is likely to grow louder as the FOMC rotating panel for 2022 takes on a hawkish bias. Despite the 2021 rotating panel having a slight dovish bias, seven out of the 18 members saw a rate hike taking place in 2023 during March’s FOMC meeting. A more hawkish Fed could see greater support for monetary policy tightening. 

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“That said, all six Board of Governors led by Fed Chair Powell still command the majority, and there has been no dissenting vote from Governors in any of the FOMC meetings since Sept 2005,” notes the report by Maybank KE’s team of analysts. In contrast to the four rotating members, who are regional Fed chairpersons, chairman Jerome Powell is backed by seven permanent members including the board of governors and the New York Fed president. 

Yet Maybank KE sees labour conditions having a greater bearing on the decision to taper QE. Should payroll gains persist at the present 3-month average pace of 524,000 per month, heated discussions about QE tapering is seen to heat up over the next one to three months. The Fed will seek to communicate their intention early via changes in FOMC statements in July or September and a tapering announcement in December to avoid unsettling markets. 

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So far, there have been little indication from Fed officials that there are any plans to start tapering. Fed Vice Chair Richard Clarida said on May 17 that “through that April employment report, we have not made substantial further progress,” while Cleveland Fed’s Loretta Mester indicated on May 14 that it would be more prudent to let the recovery continue. 

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Still, economic overheating could force the Fed to steepen the rate tightening path compared to those implied by market rates. Claida has also noted on May 25 that despite the absence of tapering plans, that “…there will come a time in coming meetings we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases. ” 

Dotplots from the March FOMC also suggest no change in Fed fund rates at 0.1% till 2023 and a long-run rate of 2.5%. Fed fund futures pricing looks hawkish regarding when the Fed can begin hiking, but the market is dovish on how quick the Fed can subsequently continue rate hikes. 

It is expected that a total increase of 150 basis points over three years following the first rate hike. This is seen to undershoot the long-run dot of 2.50% over a flatter path than the 2015-2018 “taper tantrum”. 

Maybank KE attributes this trend to the Fed’s average inflation targeting framework. Yet, they note that this trend could also be hinting at an upward repricing risk in yields if sustained payroll gains and price pressure de-anchors medium to long-term inflation expectations. 

In addition to these monetary policy discussions, the Fed is likely to raise the interest on excess reserves (IOER) or the overnight reverse repo rate (RRP) by 5-10 basis points. This is to prevent negative rates in the context of ample liquidity, since excess liquidity from QE purchases and Treasury cash continue to be a drag on short-term money market rates.