In the six weeks since the FOMC meeting in March, the rhetoric from Fed officials has become markedly more hawkish. This marks a major change from the unlikely optimism of the Fed’s latest summary of economic projections, which saw inflation dip into the mid-2% range by the end of 2023 from a high of four decades, with no increase in unemployment and only a modest hike in the central bank’s policy rate.

A 50 basis point increase in the fed funds target range, from the current 0.25% to 0.50%, is 99% certainty at the next rally, according to the fed funds futures market. What we want to know is whether further 50 or even 75 basis point hikes are likely and what the plan is to shrink the central bank’s huge balance sheet. (A basis point is 1/100th of a percentage point.)

The futures market is pricing in a target funds rate range of 2.75% to 3% by the end of the year, well above the median projection of 1.9% in March and in line with the projection FOMC median of 2.8% for the end of 2023. Significantly higher market rate expectations have lifted Treasury yields, with the benchmark 10-year yield up 56 basis points for April and 139 since the start of the year, at 2.885% on Friday afternoon. This, more than anything else, has produced the sharp revaluation of risky assets, especially stocks.

While the FOMC won’t have the April jobs report when it meets midweek, it will have plenty of other data to go on. One report he will rightly dismiss is the advance estimate of first-quarter gross domestic product, which showed an annualized real contraction of 1.4% after robust 6.9% growth in the final quarter of 2021. .

Markets immediately looked beyond the latest figure as being due to particular factors: an increase in imports which had been delayed by the safeguarding of the docks, a slowdown in stocks and a reduction in public spending after the end of the massive stimulus. Last year. Excluding these factors, real private sector domestic final sales – which the Fed influences – actually grew at a faster pace of 3.7% in the first quarter than the 2.6% in the prior period. .

More influential will be the 1.4% jump in the employment cost index in the first quarter, which took the year-over-year increase in civilian earnings to 4.5%. Powell noted last December that the ECI rally in the third quarter helped persuade him to accelerate the reduction of the Fed’s balance sheet.

What he has to say about the actual shrinking of the balance sheet will be key.

JP Morgan

expects Fed holdings to drain at an annual rate of about $1.1 trillion. The bank’s quantitative and derivatives strategy team, led by Nikolaos Panigirtzoglou, estimates that, over four years, the cumulative effect of quantitative tightening will be the equivalent of 210 basis points of rate hikes.

The problem for the Fed now is that it’s like the lost traveler to whom a local says “you wouldn’t want to start here to get there,” says Chris Brightman, CEO and chief investment officer of Research Affiliates. Having waited too long to start normalizing policy, it must now take a fast track it would have preferred to avoid in order to contain inflation.

If the central bank tries to avoid a hard landing and opts for a little more inflation, “Powell will fall like the next Arthur Burns,” Brightman comments, referring to the despised 1970s Fed chairman who left the inflation going up to double digits.

For now, the economy remains robust, with a historically low unemployment rate of 3.6% and many more job vacancies than job seekers. Financial markets seem to be suffering more than the real economy from the prospect of further Fed tightening, at least so far.

Read more from top to bottom of Wall Street:China’s plunging Yuan is a bigger threat than Twitter

Write to Randall W. Forsyth at [email protected]