Federal Reserve Policy and Outlook - Wilmington Trust
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Federal Reserve Policy and Outlook As of March 18, 2022 ©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.
Key Takeaways • At its March 16 meeting, the Fed kicked off its rate hike cycle, with a 25bp increase in the target range for the federal funds rate to 0.25% to 0.50%. • The action is the culmination of a move to a more hawkish position that started in late 2021 as price pressures broadened. That broadening led to growing concerns that inflation could become entrenched and remain high. • As a group, the members of the Federal Open Market Committee also broadly raised their expectations for future rate hikes at the March meeting, with the median projection pointing to seven hikes in 2022 (up from three projected at the December meeting) and another three to four in 2023. • The median terminal rate projection came in at 2.8%, slightly above the Fed’s long run neutral projection of 2.4%. This in line with the Fed’s acknowledgment that the easing of supply side pressures is not likely to materialize in the near term due to the Ukraine war—putting the onus on the Fed to step in to suppress demand modestly rather than just remove accommodation. • The Fed plans to announce balance sheet reduction “at a coming meeting,” which could come as soon as May. Chair Powell emphasized that the framework would be familiar to that of the last cycle, pointing to caps on reinvestment of maturing securities rather than sales of securities at this stage of the process. • The pace of month-over-month inflation gains will be the key determinant of how aggressively the Fed tightens policy. We expect inflation to slow to 4.5% year over year (y/y) by the end of 2022 from the 7.0% y/y reached in December 2021. • We think there is downside risk to the Fed median projection for two reasons. First, we expect monthly inflation to slow significantly in the second half of 2022. Second, the Fed may face issues with “yield curve inversion” if their rate hikes push short-term interest rates above long-term rates. See our Wilmington Wire post for details. ©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.
Section 1 Fed policy
Outlook for Monetary Policy in 2022
The rate hike cycle started in March 2022 with a 25bp increase. We anticipate additional hikes in May and
June before the Fed assesses the impact mid-year. Chair Powell indicated balance sheet reduction could start
as soon as May, with details expected to be released in the March meeting minutes.
Federal Reserve balance sheet (in $ trillions) and federal funds rate (%)
10 6
PROJECTIONS
5
7.5 Balance
Sheet
Reduction 4
5 3
Rate
Hikes
2
2.5
1
0 0
2005 2008 2011 2014 2017 2020 2023
Federal Reserve total assets ($ tn, left) Projections Federal funds rate - Top of range (%, right)
Data as of March 16, 2022. Sources: Macrobond, Federal Reserve.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Interest Rate Expectations – Fed and Market
The Fed started the rate hike cycle with a 0.25% increase and sharply raised expectations for future rate
increases. The most recent median projections from Fed committee members were revised up to show seven
hikes in 2022 (up from three in December), prompted by broadening price pressures and tight labor markets. if
needed as well. Futures markets are in line with Fed projections.
Federal funds rate and projections (%)
7 0.5
0.45
6
0.4
5 0.35
0.3
4
0.25
3
0.2
2 0.15
0.1
1
0.05
0 0
2003 2006 2009 2012 2015 2018 2021 2024
Recession Fed Funds Rate Futures Market FOMC Projections (Median)
Fed Funds Futures data as of March 23, 2022. FOMC Projections as of March 16, 2022. Sources: Bloomberg, Federal Reserve, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Quantitative Easing (QE)
The March 2022 meeting statement indicated that the Fed expected to reduce its holdings of Treasuries and
mortgage-backed securities on the balance sheet “at a coming meeting,” with Chair Powell indicating that this
could be as soon as May. He emphasized that the framework would be familiar to that of the last cycle, pointing to
caps on reinvestment of maturing securities rather than sales of securities at this stage of the process.
Federal Reserve balance sheet by selected assets ($ trillion)
10
COVID-19
7.5
Balance Sheet
“Normalization” starts
Jan 2018
5
QE 3
QE2
2.5 QE1
Repo Market
Scare (Sept 2019)
0
2005 2008 2011 2014 2017 2020
Securities Held Outright (Treasuries and MBS)
Liquidity Programs and Discount Window Lending
Other Assets
Data as of March 16, 2022. Sources: Federal Reserve, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Bank Reserves are an Inflation Risk
Commercial banks have built a $4.0 trillion hoard of reserves on their accounts at the Federal Reserve, up
from $1.7 trillion just before the pandemic. If these reserves make their way into the economy via loans to
consumers and businesses, they could fuel further inflation. This is a key reason the Fed is planning to
commence balance sheet reduction in 2022.
Federal Reserve balance sheet by selected liabilities ($ trillion)
10
7.5
Bank
Reserves
up $2.3T
5
2.5
0
2005 2008 2011 2014 2017 2020
Currency in Circulation Reverse Repurchase Agreements
All Other Bank Reserves
Data as of March 16, 2022. Sources: Federal Reserve, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Section 2 Labor Market
Recovery of Labor Market Still in Progress
Exactly two years after the start of the pandemic in the U.S. total jobs are down 2.1 million. Returning to the pre-
pandemic level of jobs would take until June 2022 if employers added 500,000 per month going forward. A
higher hurdle would be the pre-pandemic trend, which would take until June 2023 at that rate.
Total nonfarm U.S. jobs (millions)
160 0.5
July
2023
0.45
155
0.4
150 0.35
0.3
145
June 0.25
2022
140
0.2
135 0.15
0.1
130
0.05
125 0
2005 2008 2011 2014 2017 2020 2023
Recession Total nonfarm employment Pre-pandemic trend*
+500k per month Pre-pandemic level
*Job growth typically slows late in an economic cycle. Growth in the previous cycle peaked at 2% year-over-year (y/y) in 2014–15 and slowed to 1.4% just before the pandemic.
Here we assume a continued slowing to 1% by mid-2023.
Data as of February 28, 2022. Sources: Bureau of Labor Statistics, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Recovery of Labor Market ─ Participation
A better measure of labor market recovery would account for changes in participation rates. Workers have
started to rejoin the labor force as virus and childcare concerns ease and fiscal stimulus cushions start to fade.
Retirement and reassessment of work opportunities may be a more persistent drag. Encouragingly,
participation by the 25–54 age group moved up nearly a full percentage point (one million people) during 2021.
Labor force participation rates (%)
85 68
67
84
66
83
65
82 64
63
81
62
80
61
79 60
1997 2000 2003 2006 2009 2012 2015 2018 2021
Recession Aged 25-54 (left) All Ages (right)
Data as of February 28, 2022. Sources: Bureau of Labor Statistics, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Recovery of Labor Market ─ Unemployment by Education
In their new operating strategy, the Fed says the goal of maximum employment is “broad-based and inclusive.”
There is a new focus on different segments of the labor market, including low- and moderate-income
households, unemployment by level of education, and race or ethnicity. If the recovery of any particular
segment is lagging more than others, the Fed could delay the tightening of policy.
Unemployment rate by education (%)
25
20
15
10
5
0
2005 2008 2011 2014 2017 2020
Recession No High School Diploma High School Graduate
Some College or Associates Degree Bachelor's Degree and Higher
Data as of February 28, 2022. Sources: Bureau of Labor Statistics, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Recovery of Labor Market ─ Unemployment by Race
In their new operating strategy, the Fed says the goal of maximum employment is “broad-based and inclusive.”
There is a new focus on different segments of the labor market including low- and moderate-income
households, unemployment by level of education, and by race or ethnicity. If the recovery of any particular
segment is lagging more than others the Fed could delay the tightening of policy.
Unemployment Rate by Race or Ethnicity (%)
25
20
15
10
5
0
2005 2008 2011 2014 2017 2020
Recession White Black or African American Asian Hispanic or Latino Ethnicity
Data as of February 28, 2022. Sources: Bureau of Labor Statistics, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Section 3 Current and
Expected InflationInflation Forecast
Russia’s invasion of Ukraine is adding upside risk to the inflation outlook through higher commodity prices,
especially oil. A scenario where the oil price shock pushes the price to $125 per barrel on average through
2022 adds nearly a full percent to our previous CPI forecast. The indirect impact from supply chain disruptions
of other commodities combined with still-rising wages and normalization of housing costs pushes the forecast
to 4.5% y/y by the end of 2022.
Consumer Price Index (CPI) inflation (% change, year over year)
Projection
10
7.5 9
8
5 7
6
5
2.5
4
3
0
2
1
-2.5 0
2005 2007 2009 2011 2013 2015 2017 2019 2021
Recession Previous Baseline New Baseline CPI
Data as of March 15, 2022. Sources: Bureau of Labor Statistics, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Broadening of Inflation Pressures
Inflationary pressures from “reopening sectors” in the spring of 2021 faded shortly thereafter but were replaced
by broader price increases as labor shortages and supply-chain disruptions challenged businesses. This has
been a key driver of the Fed’s shift to a more hawkish stance, even prior to the upside risks to inflation coming
from the Ukraine war.
Core Consumer Price Index (CPI) components (percentage point contribution to monthly percent change in Core CPI) and
Core CPI (% change, month over month)
Increasing
size of grey
bars
indicates
broadening
price
pressures
Data as of December 31, 2021. Sources: Macrobond, Bureau of Labor Statistics.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Encouraging Slowdown In Alternative Measures
We prefer “trimmed mean” measures of inflation to the better-known “core” measures that strip out food and
energy items arbitrarily. The trimmed mean method strips out the highest and lowest 8% of the index each
month and does a superior job of tracking the underlying trend than does “core.” The recent deceleration in
trimmed mean CPI suggests the worst of the inflation pressures may have already passed, though the Ukraine
war presents near term upside risks.
Trimmed mean Consumer Price Index (% change, month-over-month)
0.8
0.7
0.7
0.6 Still high but
decelerating
0.6
0.5
0.5
0.5 0.5
0.4
0.3
0.2
0.1
0
Jan 2019 Jul 2019 Jan 2020 Jul 2020 Jan 2021 Jul 2021 Jan 2022
Data as of February 28, 2022. Sources: Federal Reserve Bank of Cleveland, Bureau of Labor Statistics.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Expected Inflation ─ Still in Check Says the Bond Market
The Fed wants to see “longer-term inflation expectations well-anchored at two percent.” Breakeven inflation rates
on Treasury Inflation Protected Securities (TIPS) are helpful indicators of the bond market’s implicit inflation
forecast. But TIPS are in terms of CPI inflation, which runs higher than the Fed’s preferred PCE measure of
inflation. We adjust* TIPS breakevens and find expectations five years out have crept higher, but longer-term
expectations remain near the Fed’s target.
Bond market inflation expectations (TIPS breakeven rates adjusted from CPI to PCE terms, %)
3.0
Longer-term
expectations are
just above the
Fed’s desired
2.0 level
1.0
0.0
-1.0
2002 2006 2010 2014 2018 2022
First 5 years Years 6 to 10 Fed Target
Data as of March 15, 2022. Sources: Macrobond, Bureau of Economic Analysis, Bloomberg, WTIA.
*We adjust by calculating the average difference in CPI and PCE inflation for the 10-year period from 2009 to 2019 and subtracting that value from the TIPS breakeven rates reported by Bloomberg.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Expected Inflation ─ Still in Check Say Consumers
After several years of reduced long-term inflation expectations by consumers, from 2014 to 2019, they have
recently returned to levels that prevailed for decades. We think the Fed is likely encouraged by this increase.
But if long-term expectations were to rise significantly from here, the Fed would be much more likely to
accelerate the tightening of policy, in our view.
Consumers’ inflation expectations over the next 5 to 10 years (3-month average %)
3.5
Returned to historic
norms but at risk of
running higher
3.0
2.5
2.0
2001 2006 2011 2016 2021
Data as of March 15, 2022. Sources: University of Michigan, WTIA.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.Disclosures
Advisory Service Providers Investment products are not insured by the FDIC or any other governmental agency, are not
deposits of or other obligations of or guaranteed by Wilmington Trust, M&T, or any other bank
Wilmington Trust is a registered service mark used in connection with various fiduciary and non-
or entity, and are subject to risks, including a possible loss of the principal amount invested.
fiduciary services offered by certain subsidiaries of M&T Bank Corporation including, but not limited
to, Manufacturers & Traders Trust Company (M&T Bank), Wilmington Trust Company (WTC)
operating in Delaware only, Wilmington Trust, N.A. (WTNA), Wilmington Trust Investment Advisors, Risk Assumptions
Inc. (WTIA), Wilmington Funds Management Corporation (WFMC), and Wilmington Trust Investment All investments carry some degree of risk. Investors should develop a thorough
Management, LLC (WTIM). Such services include trustee, custodial, agency, investment understanding of the risks of any investment prior to committing funds.
management, and other services. International corporate and institutional services are offered
through M&T Bank Corporation’s international subsidiaries. Loans, credit cards, retail and business
deposits, and other business and personal banking services and products are offered by M&T Bank.
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Suitability
This material is provided for informational purposes only and is not intended as an offer or solicitation
for the sale of any financial product or service or as a recommendation or determination by
Wilmington Trust that any investment strategy is suitable for a specific investor. Investors should
seek financial advice regarding the suitability of any investment strategy based on their objectives,
financial situations, and particular needs. The investments or investment strategies discussed herein
may not be suitable for every investor. This material is not designed or intended to provide legal,
investment, or other professional advice since such advice always requires consideration of
individual circumstances. If legal, investment, or other professional assistance is needed, the
services of an attorney or other professional should be sought.
The opinions, estimates, and projections presented herein constitute the informed judgments of
Wilmington Trust and are subject to change without notice. Expected return information in this
presentation is derived from forecasting. Forecasts are subject to a number of assumptions
regarding future returns, volatility, and the interrelationship (correlation) of asset classes. Actual
events or results may differ from underlying estimates or assumptions, which are subject to various
risks and uncertainties. No assurance can be given as to actual future market results or the results of
Wilmington Trust’s investment products and strategies. The information in this presentation has been
obtained or derived from sources believed to be reliable, but no representation is made as to its
accuracy or completeness.
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and its affiliates
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