Risks in Fed Tightening

Short-term investors are feeling the pinch in the Federal Reserve’s fight against inflation.

According to the April “Strategic Liquidity Solutions” report from Insight Investment, liquidity in markets for short-term investments decreased substantially in the first quarter of 2022. Moreover, total returns on short-term investment strategies were negative through March, as markets priced in changing interest rate expectations.

“The ultra-low starting point in yields compounded the effect, leading to the worst bond market performance in decades,“ says the report.

“Investors responded to the changing Fed narrative and rising geopolitical uncertainty by shortening weighted average maturities and preemptively raising cash,” the report explains. “This desire to raise contingent cash, or buffer, coincided with the Fed’s first interest rate hike and the obvious geopolitical uncertainty. Liquidity conditions as a whole deteriorated and remain less than ideal.”

Adds Jason Celente, senior portfolio manager at Insight Investment: “Against the current inflation and unemployment backdrop, the Fed and other central banks must choose amid a myriad of bad policy options. Fed Chair Powell’s desire to engineer a continued economic expansion seems incongruent with current circumstances. The Fed risks either reducing aggregate demand by tightening too much, or entrenching expectations for long-term inflation above the 2 percent target if it tightens too little.”