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7
Kalemu_Wang
00:00
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Developments in Financial Markets and Open
Market Operations
The manager turned first to a review of global financial
market developments. Following the Russian invasion
of Ukraine and the subsequent imposition of an array of
sanctions, the ruble depreciated roughly 40 percent
against the dollar. Prices of dollar-denominated Russian
bonds plunged 80 to 90 percent, and local trading of
Russian equities was suspended after a precipitous decline in Russian stock price indexes. Global financial
conditions tightened, reflecting declines in equity prices,
increases in sovereign yields and credit spreads, and—
for the United States—an appreciation of the dollar.
Prices of commodities that Russia exports, particularly
oil and natural gas, soared over the period. While oil
prices partially retraced late in the period, options prices
suggested considerable probability that oil prices could
remain elevated or rise further in the months ahead.
Alongside the rise in commodities prices, measures of
near-term inflation compensation increased sharply
across advanced economies. In Eastern European
countries, currencies depreciated notably and equity
prices declined, but most emerging market currencies
outside of Eastern Europe depreciated only modestly or
rose. Sovereign spreads for emerging market economies
(EMEs) widened, but the moves outside of Eastern Europe were relatively modest.
The developments in Ukraine sparked some liquidity
strains across markets. Overnight interest rates were
steady throughout the period, but there were some signs
of pressures in term funding markets. High levels of reserves in the banking system and the backstop facilities
in place—the new repurchase agreement facility for foreign and international monetary authorities (FIMA Repo
Facility) and the standing repo facility (SRF), as well as
the standing central bank liquidity swap lines and the discount window—likely supported market confidence regarding the availability of liquidity and helped contain
funding pressures. Amid a rise in market volatility, trading liquidity declined across a number of sectors. In the
Treasury market, market depth fell and the price impact
of trades increased modestly in some sectors. Overall,
however, volumes were typical, and markets continued
to function in an orderly fashion.
Notwithstanding uncertainties associated with geopolitical developments, many central banks continued to signal intentions to move ahead with reducing policy accommodation to address elevated inflation. Marketimplied policy rates one year forward rose notably across
many advanced foreign economies (AFEs), extending
increases seen over recent months.
In the United States, incoming economic data and Federal Reserve communications led investors to expect a
more rapid removal of policy accommodation than they
had previously expected. Market participants almost
universally expected a 25 basis point increase in the target range for the federal funds rate at the current meeting. Moreover, futures prices implied that the federal
funds rate would increase around 170 basis points
through year-end, about 70 basis points more than had
been priced in at the time of the January meeting. Similarly, the median projection of the target range for the
federal funds rate in the Open Market Desk’s most recent surveys of primary dealers and market participants
showed an increase of 150 basis points this year. The
median projected path for the target range beyond 2022
rose another 100 basis points by the first half of 2024 to
a level modestly above the median projected longer-run
level before returning closer to the longer-run level in
2025. Consistent with shifting expectations for the path
of policy, shorter-dated Treasury yields rose notably
over the intermeeting period and the spread between the
10-year Treasury yield and 2-year Treasury yield narrowed.
Market participants expected an earlier and somewhat
faster reduction in System Open Market Account
(SOMA) holdings of securities than they did in January.
In the Desk surveys, almost 90 percent of respondents
projected balance sheet runoff to begin by July. Overall,
survey respondents expected a significant reduction in
the balance sheet over coming years, although there was
a high degree of uncertainty around the magnitude of the
total decline.
The manager turned next to a discussion of money markets and policy implementation. Market participants expected the interest on reserve balances rate and overnight reverse repurchase agreement (ON RRP) offering
rate to be increased by 25 basis points at the current
meeting, in line with their expected increase in the target
range, and anticipated that the changes would fully pass
through to market overnight interest rates. There was
uncertainty around how ON RRP usage might evolve in
the near term as money market rates increased. If banks
lifted their deposit rates by less than the increase in returns available on alternative investments, depositors
could shift funds into these alternatives, leading to
downward pressure on rates and increased ON RRP
take-up. If instead deposit rates moved up in line with
net yields on alternative investments, ON RRP takeup
could remain relatively steady. Over the longer term,
however, ON RRP balances were expected to decline as
the Federal Reserve’s balance sheet runoff proceeded
and gradually lifted money market rates relative to the
ON RRP rate.