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Fed raises rates, but sparks broad market rally by ruling out 75-bps hikes

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By Eric Stein, CFAChief Investment Officer, Fixed Income, Eaton Vance Management

Boston - As widely expected, the Federal Open Market Committee (FOMC) raised the federal funds rate by 50 basis points (bps) at its May 3-4 meeting, to a target range between 0.75% and 1%. But the real headline — and by far the most important thing — was Fed Chair Jerome Powell's statement that the Fed is not "actively considering" steeper hikes of 75 bps.

Powell made clear at his press conference that the Fed is concerned about inflation, and is in a tightening mode. That includes the decision to begin quantitative tightening (QT), starting at $47.5 billion per month of reduction in its portfolio of Treasury and mortgage-backed securities (MBS), and increasing to $95 billion after three months.

Risk markets rallied sharply in response to Powell's comments on May 4. For the previous two weeks, there had been much discussion in the financial markets about the potential for a 75-bps hike. By clipping that possibility from the distribution of outcomes — a tail risk, if you will — the Chair sparked a broad rally in risk markets.

On May 4, equities surged and foreign currencies gained sharply against the U.S. dollar. In the bond market, we witnessed a significant "bull steepening." At the long end of the curve, the 30-year Treasury remained largely flat, while the front end fell by 14 bps.

Bottom line: The Fed is quite clear that it needs to continue tightening to rein in inflation, and anticipates that more volatility will be part of the process. Powell said that 50-bps rate hikes are likely at the next FOMC meetings in June and July. But for one day at least, by taking the prospect of a larger hike off the table, Powell gave the markets a reason to cheer.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.