Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group

The Federal Open Market Committee (FOMC) voted to maintain the current Fed Funds rate at the zero lower bound (0.00%–0.25%) and accelerate the pace of tapering its asset purchase program by 30bln per month starting in mid-January. The Committee viewed that inflation was becoming broader-based, no longer using the word “transitory” to describe the rise in prices.

Committee Statement

• Economic Assessment – The economic assessment was shorter and reflected several facts to justify the decision to accelerate the taper: inflation has exceeded the target of 2% for some time, inflation is elevated due to supply and demand imbalances, and unemployment has declined substantially. Of note, they removed the word “transitory” from the statement.
  
  
• Outlook – The Fed continues to view the path of the economy as dependent on the course of the COVID-19 virus, as well as the ongoing supply constraints and their ripple effects on economic activity, employment, and inflation. They highlighted new COVID variants as a specific risk to the economic outlook.
  
  
• Current Policy and Forward Guidance –
  
  
  • The Fed announced an accelerated pace of purchases starting in mid-January which would reduce the pace by 30bln per month (compared to the prior pace of 15bln per month) assuming economic conditions develop as the Committee currently anticipates.
    
    
  • On the timing of rate hikes, the Committee sees that PCE has already reached and exceeded 2% for some time. They removed the sentence on longer term inflation expectations. As a result, the latest guidance solely references the labor market as a reason for policy rates to remain at zero; once they achieve full employment, they will change the target range.

Summary of Economic Projections

Investors received FOMC participants’ revised outlooks for growth, inflation, employment, and policy rates expectations through 2024. Growth expectations were downgraded in 2021 and 2023 but upgraded in 2022. On inflation, expectations were revised up significantly with forecasts for core PCE increasing 0.7% to 4.4% in 2021, 0.4% to 2.7% in 2022, 0.1% to 2.3% in 2023, and steady at 2.1% in 2024. Taken together, the median of the committee continues to expect inflation above 2% throughout the forecast horizon. Additionally, 15 out of 18 participants now view the risks to their forecasts as being weighted to the upside – a new record high. The unemployment forecast was revised lower by 0.5% to 4.3% in 2021, before steadying out at 3.5% in 2022-2024.

The dot plot gave us a refreshed indication of the Committee’s expectation for the start date of rate hikes and the appropriate pace after liftoff. The median of the committee now expects 8 rate hikes through 2024 starting in 2022. The median of the Committee expects three rate hikes in 2022 and 2023, and two rate hikes in 2024. The Fed’s long-run neutral rate of 2.5% was not changed.

Chair’s Press Conference

At the press conference, Chair Powell reiterated his more hawkish views first revealed at his Congressional Testimony at the end of November.

• Labor market: The Chairman sees the labor market as getting tighter and in some cases being “hotter than it ever ran in the last expansion”. He cited record quits and vacancy rates as well as rising wages. The two big threats to maximum employment were viewed to be 1) the pandemic 2) lack of price stability.
  
  
• Inflation: Chair Powell discussed how his view on inflation has evolved. He described the strong Q3 ECI wage report as well as recent hot CPI prints as the catalysts. At this point, while he does not see a wage-price spiral and still generally sees high inflation being driven by goods, he is watching wages and shelter prices closely to see where inflation will settle. He viewed the risk of inflation becoming persistent and entrenched as having increased but not being high overall.
  
  
• Balance Sheet: Chair Powell discussed the Committee’s decision to accelerate the pace of taper due to continued strong inflation and labor market developments. He felt that doubling the pace was appropriate given that at the new pace of reductions QE would be over in two more meetings. The Chairman indicated the FOMC also had begun very initial discussions about balance sheet sequencing but no decisions have been made.
  
  
• Rate Hikes: Chair Powell remained open minded about the time between the end of QE and rate hikes. While no decisions have been made, he doesn’t see an “extended” wait before rate hikes are appropriate because inflation and employment are so much stronger than in the last cycle.
  
  
• COVID 19: In the wake of the Omicron variant, the Fed still sees the virus as a risk with a lot of uncertainty. However, unless the Omicron variant produces significant economic impacts, it will likely not alter the Fed's trajectory.

Our View:

• The traditional disinflationary cycle that occurs after a recession has been short-circuited by the immense fiscal and monetary policy response. Shelter and wage inflation are showing enough signs of persistence that even after transitory factors fade, it is becoming increasingly clear that inflation will remain far above the Fed’s mandate for longer than previously expected, and when it does moderate, it will likely be at levels that remain above 2% on Core PCE.
  
  
• Given the robust inflation and labor market backdrop, we believe the Fed will maintain its accelerated pace of tapering, thus bringing QE to a conclusion by March. As we move into 2022, continued improvement in the labor market, as well as persistent strength in shelter prices and wages, will result in the Fed starting to hike rates by June 2022, and hiking 25bps each quarter thereafter until they reach a mid-point of 2.375% (the high in the last cycle) in mid-2024.
  
  
• U.S. Treasury yields should be biased higher as a result of continued robust nominal growth and the Fed’s removal of policy accommodation. We expect the 10-year U.S. Treasury yield to rise to a range of 1.875%–2.375% by mid-year 2022.