By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters] – Asset markets all over the world are reeling from fears about a Federal Reserve becoming more hawkish. The central bank’s monetary policy meeting this week may provide some insight into its intentions.

The Fed will signal Wednesday to investors that it intends to increase rates in March. This would be the Fed’s first move since it cut borrowing costs almost two years ago. As the central bank attempts to control inflation, Fed funds futures are able to forecast four additional rate increases in 2019.

It is expected that the Fed will also issue a final set instructions regarding its asset purchase program. This process started in November, and will end at the present pace around mid-March when the first rate rise may take place.

The Fed’s future with the nearly $9 trillion of balance sheet remains a concern. Fed Chair Jerome Powell will likely shed additional light on this outlook during his Wednesday press conference, which will be held after the end of the two day meeting.

US Treasury, TIPS yields and inflation expectations https://fingfx.thomsonreuters.com/gfx/mkt/byvrjmyeave/US.%20Treasury%20yield%20and%20inflation%20expectations.PNG

Fears of the Fed’s end to its ultra-easy monetary policy have hit markets. They are causing havoc in some of the most important growth and technology companies, as well the “meme” stocks which first came into the limelight almost exactly one-year ago.

It is currently down 14% for the year and has just suffered its biggest weekly loss since March 2020. Meanwhile, yields on the 10-year Treasury note benchmark have increased 30 basis points in November due to a decline in government bonds. The most speculative asset, cryptocurrencies have suffered a severe beating. Bitcoin lost 25% this month.

How long this turbulence will continue depends partly on how fast the Fed raises interest rates to combat inflation. In December, it rose at the fastest rate in almost four decades.

Peter Cramer of SLC Management’s insurance portfolio management, stated that “The Fed certainly is sensitive to the equity marketplace, but I don’t believe it changes anything about the meeting.”

He added that if the sell-off reaches the broader economic and has an impact on the energy banking, consumer cyclical names, I believe the Fed might question their direction.

The history shows the central bank is likely to try and avoid further rattling market prices by increasing rates 25 basis points per year. Since May 2000 when the Fed raised rates by 50 basis points, it has never increased them by more than 25 basis point in a single policy decision.

Lou Crandall (chief economist, Wrightson ICAP, LON:) stated that the Fed had conditioned markets to expect gradualist tightening. They may be afraid of moving too fast to surprise them in unexpected ways.

Some have called for a 50-basis move but it hasn’t stopped others from arguing that this would enable the Fed to quickly stop inflation.

David Petrosinelli (managing director, senior trader at InspereX New York), stated that the Fed should “do 50 basis points” because of a policy mistake. It will be a powerful signal that the Fed cares about inflation.

Bill Ackman (CEO U.S. Pershing Square Capital Management) called two weeks back for a 50-basis points increase at the March meeting in order to “restore credibility” through a series comments posted on Twitter.

Petrosinelli says that this is unlikely as it will shock market. Petrosinelli’s sentiments were also shared by Christopher Waller (Federal Open Market Committee Governor), who was one of more hawkish members.

In fact, Monday’s probability of a 50 basis point increase in interest rates was 5.2%.

Goldman Sachs (NYSE 🙂 wrote that there was a possibility the Fed might “take some tightening actions at every meeting after March” as long as inflation-boosting supply chains are not disrupted.

Other than raising rates, the Fed can also use other tools, like “quantitative loosening”, or shrinking its balance sheets. It has suggested that it might begin to do so sometime this year.

US Fed balance sheet and govt bond yields https://fingfx.thomsonreuters.com/gfx/mkt/lgvdwjyaypo/Fed%20balance%20sheet%20and%20bond%20yields.PNG

Cramer of SLC said that a balance mix rate increases and quantitative tightening will less likely to stimulate financial markets.

According to him, a run-off in the balance sheets of $350-$550 billion amounts to roughly a 25-basis-point hike.

Cramer explained that U.S. inflation is due to an imbalance of the supply. “Rate hikes that are faster can really choke down demand, and I don’t know what the Fed will do there.”