Looking at the Fed's balance sheet, the H.4.1.statistical release "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks," we see that between June 22, 2022, and July 15, 2022, securities held outright by the Federal Reserve declined by $37.3 billion. This effort seemingly began three weeks ago. The Federal Reserve has also included in its plans for a tighter monetary policy to reduce the size of its securities portfolio. Thus, the Fed's tighter monetary policy is being transmitted to the financial markets.
So, for the first time in this round of monetary tightening, we have an inverted yield curve.even at these very low interest rates. Since then, more and more of the yields on longer-term Treasuries dropped below the yield on the two-year Treasury. Starting on July 5th, a longer-term yield dropped below the yield on the two-year Treasury security. Historically, when monetary policy starts to get tighter, the term structure of interest rates always inverts with shorter-term interest rates rising above longer-term interest rates. That is, inflation over the next five to ten years is not expected to be too much higher than the inflation target of the Federal Reserve System and is expected to be lower over the ten-year period than in the five-year period.įurthermore, in terms of the impact of monetary policy, we now see the term structure of interest rates now turning negative. Treasury securities we see the expected inflation built into five-year maturities and for ten-year maturities are in the two percent range and we also see that inflation is expected to be a lot stronger in the five-year period than in the ten-year period. That is, the markets are facing a strong movement in prices, but this strong movement is not going to last very long.Īs a consequence, the inflationary expectations built into yields in the bond market are not very great and they imply that the current round of inflation will be falling off quite soon.įor example, calculating the breakeven yield for interest rates on U.S. It seems like the current picture painted by the financial markets is that inflation is not going to last very long. Much of the current debate going on concerning the monetary policy of the Federal Reserve has to do with the length of the current wave of inflation.
The new inflation figures have just added to the urgency to raise the Federal Funds rate higher, but also to do it faster. Some analysts are even talking about the need for the top of the Federal Funds rate to go to 4.50 percent or even more. Meanwhile, many analysts are calling for an even greater rise in the Federal Funds rate over the next six months or more. So, the Fed still has ways to go in its efforts to bring inflation under control. For 2023, the FOMC saw the Federal Funds rate going to 3.8 percent. That would bring the top of the policy range up to 2.75 percent.Īt its latest meeting, the FOMC projection for the Federal Funds rate in 2022 was 3.4 percent. Up until Wednesday this week, the best bet for the Fed's next policy rate move was 75 basis points.Īfter the latest inflation figure was released, a 9.1 percent rise in June from June 2021, there is more talk that the next move by the FOMC would be to raise the rate by 100 basis points. The effective Federal Funds rate has been held steady at 1.58 percent. Right now, the range for the Federal Funds target runs from 1.50 percent to 1.75 percent. The policy-making committee of the Federal Reserve will assemble again to determine what the Federal Funds rate target should look like.
The Federal Open Market Committee meets again on July 26 and 27.