And now? The war in Ukraine has caught the Federal Reserve in a difficult position. Its tightening, in fact, has already begun, even if no rate hike has been decided, but the war tensions have made a difficult situation in terms of inflation even more serious: it has strengthened the component linked to the supply side , which monetary policy certainly cannot attack, while inflation expectations have risen rapidly.
Expectations: a “hawk” Fed
The expectations of analysts and financial operators, not unanimous, however point to a rise in rates, and an indication that the squeeze will be closer. Inflation in the US is high, overt – it tends to affect all prices – and largely linked to demand. A signal – whether it is still verbal, as everyone expects, or even “real” – is in any case appropriate. Uncertainty, it is true, has risen sharply, but from a risk management perspective it does not rule out a first rate hike.
Expectations towards 3%
The problem is expectations. Too high by now to be compatible with the objective, albeit revised and “average” of 2 per cent. The Federal Reserve has often considered market expectations to be relatively unreliable because other factors – essentially the risk premium and the liquidity premium – can alternate their indications. If the 5- and 10-year break evens – the yield differences between index-linked and non-price-indexed securities – may signal greater demand for bonds that protect against inflation, the prices on swaps, not surprisingly lower, are in any case in strong rise. Referring to a relatively distant time horizon, they can be a source of some concern.
Financial conditions at 2018 levels
On the other hand, it is true that financial conditions are already beginning to normalize. They are already, excluding the jump linked to the outbreak of the pandemic, at levels abandoned at the end of 2018, when the “official” rates on Fed Funds were between 2.25 and 2.50 per cent. The rise in the Chicago Fed index, which summarizes more than a hundred different indicators, appears rather rapid, and begins to coincide with the outbreak of hostilities.
Rising yields
The two main components at the beginning of the monetary policy transmission chain are already signaling strong, market-driven hikes. Government bond yields have risen to prepandemic levels throughout the medium and long term, while for the short term – under the modulated control of monetary policy – it remains at lower levels.