The Fed on a ridge line

The meeting of the US Federal Reserve’s (Fed) Monetary Policy Committee on March 16 and 17, 2021 is particularly eagerly awaited. In a context of nervousness in the interest rate markets, and as the European Central Bank expressed its determination to counter any tightening of financial conditions at its meeting on March 11, investors question the degree of tolerance of the Fed vis-à-vis these upward adjustments in the bond markets.

In fact, the Fed finds itself in an uncomfortable situation, between short-term concerns and medium-term prospects.

Looking at the medium term, the current hike in US rates is an ideal scenario for the Fed, which above all fears repeating the mistakes of the past. In 2013, the ill-prepared announcement of the reduction in securities purchases caused a crisis in the markets, the famous “ type tantrum “. For the moment, all is well: the recent rate hike has been absorbed very well by the markets: equities are advancing, the credit market remains well oriented and inflation expectations remain contained… We are not anticipating any announcements. reduction in purchases probably before the end of this year, for effective implementation in 2022. But it is obvious that higher long rates, and therefore more compatible with a less accommodating monetary policy in the future, are rather welcome for a central bank very concerned about financial stability.

From a more short-term point of view, its tolerance for rising rates is undoubtedly more limited. It should be noted that the economic recovery remains fragile, especially on the employment front, with a participation rate which, at 61.4% in February, remains below the 63.4% before the crisis. On the inflation side, the 2% target is still a long way off: if the consumer price index (CPI) in February rose 0.4% from January and 1.7% year on year, the core index (“core CPI“), which excludes energy and food, is up only 0.1% month-on-month and 1.3% from February 2020. In a context where the Fed is still far from achieving its objectives of full employment and price stability, any runaway on rates – and therefore a significant tightening of financial conditions – would be unwelcome, and could therefore trigger its intervention.

It is therefore all a question of measurement: it is very likely that the Fed will indicate to the markets that it will not tolerate a too rapid and too sharp hike in rates and that it has all the tools necessary to counter these developments, thus remaining true to its line of conduct, which is that there is less risk in doing more than doing less.

If his determination could limit the upward trend in rates for a moment, it will nevertheless be difficult to prevent it, as higher rates de facto reflect the prospects of a return to strong growth over the next two years. Against this backdrop, interest rate markets are likely to remain volatile.