IInterest rates are currently in a target range of between 2.25% and 2.50% after the last high of 75 basis points hit by the Federal Reserve this week. The increase comes in response to June’s unexpected CPI of 9.1% as the Fed remains committed to its fight against inflation.
The fed funds target is now at the top of the range of the last rate hike cycle in 2018, but it happened at an astronomically faster pace. The previous rate cycle of 2018 took three years to get to this point, while the current cycle took place in just four months, explained Kevin Flanagan, head of fixed income strategy at WisdomTree, in a recent blog post.
“If my eyes are not mistaken, in the modern history of monetary policy, the Fed has never raised rates in consecutive increments of 75 basis points, leading to an incredible total of 225 basis points. rate hikes in just four months,” Flanagan explained.
“Think about it for a minute… As recently as March 15 of this year, the Fed Funds were still at ‘zero’! Yes, we’ve blogged about the Fed’s ‘frontloading’ in its rate hikes before, but that takes it to another level,” Flanagan pointed out.
Something else that’s been happening relatively quietly in the background, for now, is the Fed’s balance sheet reduction as it practices quantitative tightening alongside rate hikes. According to Flanagan, as of 7/27/22, the Fed’s combined holdings of Treasuries, mortgage-backed securities (MBS), and agency securities had been reduced by only $17.6 billion since the start of reductions in June. Treasury bill cuts ($36 billion) were offset by MBS gains of $19 billion.
“In other words, QT hasn’t really started in a visible way yet. According to the Fed’s “Plan to Shrink the Size of the Federal Reserve Balance Sheet” from the Fed, the pace of QT should pick up and reach the maximum monthly drawdown levels from September,” Flanagan explained.
Economic impacts and volatility forecasts
Today’s GDP report of an annualized contraction of 0.9% shows the impact of the aggressive and anticipated increases. Bond market volatility has been pronounced this year, and with rate hikes scheduled for the Fed’s three remaining meetings this year, the only uncertainty concerns the amount of each increase.
“Powell & Co. are about as data-driven as I’ve ever seen in their decision-making process on this front,” Flanagan wrote.
In the current rising rate environment, 10-year Treasury yields have been on a rollercoaster ride, reflecting bond volatility and lingering uncertainty around upcoming rate hikes later this year, as well as the The evolution of inflation and the economy “should keep the ‘volatility quotient’ high accordingly,” Flanagan predicted.
WisdomTree offers a variety of fixed income ETFs for investors in a rising rate environment, including the hugely popular WisdomTree Floating Rate Cash Fund (USFR)the WisdomTree Yield Enhanced US Short-Term Aggregate Bond Fund (SHAG)and the WisdomTree Short Term U.S. Corporate Bond Fund (SFIG).
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