By Jamie McGeever

ORLANDO FL (Reuters) – The U.S. Interest Rates are climbing faster than anticipated after Wednesday’s Federal Reserve Liftoff. It brings to an end the zero-interest-rate policy or “ZIRP” that had been in place since 2008.

The money markets indicate that Fed’s unusually aggressive position on inflation will slow down the economy. It may have to reduce rates as soon as next year’s second half, or even by 2024.

However, traders aren’t pricing in recession yet. The Fed Funds Rate would be reduced to “neutral” in the coming years, from its current “restrictive” level. This will signal an end of the easing cycle.

Over the next three to five years, the Eurodollar curve will not show the Fed’s benchmark rate dropping below 2.25%. This floor was close to 2.00% before Wednesday’s meeting, and Fed Chair Jerome Powell’s press conference.

No one would like to see inflation rise again so we don’t want to restrict our monetary policies. Powell stated that the goal is to get rates to more neutral levels quickly and to then move beyond that, if necessary.

Powell, however, cites the latest median forecasts which show that the fed funds rates will rise above the long-term neutral, and states: “And as can be seen, it is appropriate.”

2024 EURODOLLAR INSVERSION

Wednesday’s Federal Reserve hiked its target range for fed funds by 25% to 0.25-0.50%. This is the first increase since 2018, and was expected. The surprise for the markets was how far policymakers will go to stop inflation.

The median Fed interest rate was 1.9% for this year, and 2.8% over the next two years according to new projections. This is significantly more than the projections of 0.9% and 1.6% at December’s policy conference.

It’s equivalent to seven quarter-point increases this year and will increase to at most 10 next year. Also, the new “terminal rate” of 2.8% will be higher than 2.4% projected. This is the rate at which the economy does not run too hot or too cold.

This led to the Eurodollar curve intensifying the hawkish refricing even before Russia’s incursion in Ukraine three week ago. It also put fuel under the oil prices and raised inflation expectations.

Inverting the June 2023-December 2020 part of the curve slightly indicates a slim chance of a rate reduction in the second half next year. However, the larger bets for a policy shift in 2024 were made.

Two weeks prior to Russia’s invasion of Ukraine on February 10th, the Eurodollar strip saw the first indications of this. Various parts of the curve 2024 were inverted at that time. On Wednesday, these bets grew.

GOOD LUCK

Because perceived credit risk can cause the Eurodollar curve to be distorted and market participants may demand strong hedging, implied rates are subject to a premium. It is nevertheless a useful guide for Fed expectations so it’s worth noting the flattening.

It may be in a period of not-so-great recession. If traders believe that the economy will shrink over the next few years, then they are likely to bet on rate cuts of 25 bps or more.

With the exception of 2020’s last recession, however, there will be a greater amount of maneuverability by the Fed. This COVID-triggered decline in GDP was both the worst and the fastest in American history.

Fed cut interest rates 150 basis points, brought back ZIRP and started a massive bond-buying campaign. Inflation is so high that no rate-cutting cycle can be seen in the money market pricing. Not yet, at least.

There are two reliable indicators of recession that give signals different: The plunge in U.S. consumer confidence indicates that recession is possible; however, Wednesday’s flattening of the 2-year/10 year yield curve did not result in an inversion yet. This suggests it is very unlikely.

The Treasury yield curve has been inverted or very close to it for many quarters before a downturn in the business cycle. We are currently at Fed rate liftoff,” Stephen Gallagher, SocGen, wrote to clients.

Others, such as Joe Lavorgna from Natixis are more skeptical that the Fed will be able to tighten enough financial conditions to bring inflation down to 2% without affecting employment and demand, or ultimately, economic growth.

Jay Powell and his company deserve the very best. They won’t get as far as they want unless they are willing to let a lot more people go without jobs. Lavorgna stated that we will experience a recession.

(The views expressed in this article are the opinions of the author. He is a columnist with Reuters.

(By Jamie McGeever; Editing by Leslie Adler)