Chart of the week

Investors bracing for a potential policy mistake?

Investors expecting rapid rate hikes, followed by a quick reversal? Our chart looks at market expectations for a possible policy mistake.

April 29, 2022 | 2 minute read

Market expectations for Fed funds rate

Source: Bloomberg Finance, L.P., FS Investments, as of April 27, 2022. Long-run Fed rate expectations are represented by the 3-month Eurodollar futures curve.

  • Equity volatility escalated this week as investors attempt to manage through an increasingly challenging combination of macro conditions. Among the range of factors dampening sentiment – the escalating war in Ukraine, an unrelenting climb in commodity prices and inflation – Fed policy expectations has perhaps moved front and center this year.
  • The market currently expects rapid action from the Fed, which should come as no surprise given policymakers’ rhetoric over the past several months. As the chart highlights, investors anticipate between seven and eight more rate hikes between now and June 2023, with the Fed funds rate peaking at 3.4%, up from expectations for a peak of approximately 3.2% about a month ago.1
  • What comes next may be more notable as investors expect policymakers to quickly reverse policy, easing rates again for the following two years. In other words, markets are bracing for an economic slowdown following the current rate hike regime.
  • These expectations are consistent with historical Fed rate hike cycles. In all but two instances since the 1970s, Fed rate hike cycles have necessitated rapid rate cuts as economic conditions slowed too much.
  • It’s fair to say that the U.S. economy remains on solid footing today, with both consumer and corporate balance sheets relatively strong. Despite the current economic resilience, markets could remain volatile for the foreseeable future if investor expectations for a rapid cycle of rate hikes this year followed by a potential economic slowdown indeed play out.

  • Bloomberg Finance, L.P., FS Investments, as of April 27, 2022. Long-run Fed rate expectations are represented by 3-month eurodollar futures curve.

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