David Randall, Davide Baruscia, and Saqib Ahmed

NEW YORK (Reuters). Investors have been racing to determine how tight monetary policy the economy can handle, as the U.S. Federal Reserve launches its rate-hike cycles. While some expect a steeper path ahead of others worried about potential missteps, others are focusing on the positives.

The Fed’s first rate hike since 2018 on Wednesday was baked into markets, but the central bank surprised by projecting the equivalent of a quarter-percentage-point rate increase at each of its six remaining policy meetings this year.

While raising interest rates can help curb the skyrocketing rate of inflation that has been affecting people’s purchasing power, they run the risk to crimp growth and cause a recession. Jerome Powell, Fed Chair, expressed optimism that the economy can thrive despite less accommodating policy.

Andy Kapyrin (chief investment officer at RegentAtlantic) stated that “The Fed” is trying to correct the ship. “I expect that they will become more hawkish in the coming year, particularly if inflation remains high.”

Kapyrin is increasing overweights in value stocks – shares of comparatively cheap, economically sensitive companies that tend to thrive in an environment of strong growth and higher rates – as well as floating rate bonds he expects to benefit from rising borrowing costs.

Some compared the Fed’s speed to Paul Volcker in his fight against double-digit inflation. Analysts at Bespoke said that Powell is having a “mini Volcker moment.”

Some were reassured by the Fed’s clear projection of rate hikes and its insistence that the economy can handle the combination of tightening policy, higher inflation, and volatile commodity prices following the invasion of Ukraine.

Jay Hatfield (portfolio manager, Infrastructure Capital Advisors) stated that the biggest overhang on the market was uncertainty about the Fed’s actions. “Now we have a rate track,” Jay Hatfield said.

Investors took the Fed’s decision to increase its inflation fighting efforts as a relief, and the benchmark ended up more than 2 percent.

But, rate rises and tightening of the balance sheets could impact the economy. Powell stated that details about reducing Fed’s almost $9 trillion balance sheet may be available in May.

Troy Gayeski Chief Market Strategist for FS Investments said, “It’s good that they left a little unclear when they will begin reducing the balance sheet.” We are concerned about the ability of the markets to continue functioning if they start to reduce their balance sheets more aggressively.

EYES ON RISK

The Treasury market showed some concern about future growth, with yields on shorter-dated Treasuries increasing above those of longer-dated Treasuries, which is a sign investors are concerned about economic risk.

Two-year and 10-year yield curves flattened. Five-year yields fell to their lowest since October 2018, while the gap between 5-year bonds and 30-year bonds shrank. Yields on five year notes rose higher than those on 10-year notes. This inversion was the first since March 2020.

The inverted yield curve can be used to predict past economic downturns. However, the parts most often associated with recession are not yet inverted.

Joe Bell is chief investment officer for Meeder Investment Management. He stated, “The longer the curve stays flattened or flattens, or it starts inverting through the curve, that will be a concern.”

Fed policymakers started to ignore the risks to the global economy and lowered their estimate of gross domestic product growth for 2022 from 4% in December to 2.8%.

Matthew Nest (global head of fixed income active), stated that they don’t have the best record for engineering “soft landings.” State Street Global Advisors (NYSE:) Who expects that the economy will shrink in the first six months of 2023.

Tony Rodriguez (head of fixed income strategy, Nuveen), said that there could be some relief in the event that commodity prices fall. He is currently moving to low-quality mortgage bonds and corporate bonds with high yield. He said that this could put pressure on the Fed to raise rates as high as they have projected.

He stated, “If anything has been learned in the past two-years it is that the Fed’s economic projections have more often than they are a little off base.”