About four months ago, markets were pricing in a strong chance that there would be no interest rate hikes from the Federal Reserve in 2022.
But rising inflationary pressures and a faster-than-expected labor market recovery have tilted Fed officials toward a more aggressive path of pulling back on its pandemic-era stimulus. Goldman Sachs, Evercore ISI, and Deutsche Bank are now among the Fed watchers predicting short-term interest rates will be 100 basis points higher by the end of 2022 than where they are now.
“We revise our Fed outlook again given plummeting unemployment, strong wages, and anticipation of another hot inflation print,” said Evercore ISI’s Krishna Guha in a note Monday.
Betting markets now show a roughly 75% chance of the first interest rate hike in March, with a 30% chance of four total hikes by the end of the year.
The U.S. 10-year Treasury (^TNX), a proxy for nominal interest rates over the longer-term, also appears to be repricing Fed rate hikes.
Since the Fed announced that it would move more quickly to end its pandemic-era policies of expanding its balance sheet through open market asset purchases, the yield on the 10-year has jumped over 30 basis points, to as high as 1.81%.
One interpretation of the rapid market movements: that the Fed is playing catch-up with a U.S. economy that could be heating up. High demand and supply chain bottlenecks are leading to price increases of almost 7% on a year-over-year basis. The unemployment rate ended 2021 at 3.9%, below the forecasts of Fed Chairman Jay Powell or any other Fed policymaker.
“Even if they do raise rates four times this year and start to shrink the balance sheet – relative to where the business cycle is — unemployment, GDP, inflation, you could still argue that they're behind the curve relative to the last cycle,” MKM Chief Economist Michael Darda told Yahoo Finance.
Liftoff
If the Fed follows through on interest rate hikes this year, the central bank will have moved much faster to tighten policy than it did after the 2008 financial crisis.
In the last economic shock, the central bank took seven years to start raising interest rates. If the Fed hikes rates in March this year, it will have only taken them two years from the time COVID-19 shut down the U.S. economy.
Still, rate hike forecasts have a history of being wrong about the timing of Fed liftoff, or the first 25 basis point increase after backing rates to zero. Fed funds futures markets, the main betting markets for future Fed policies, had priced in fair odds of the first post-Great Financial Crisis rate hike as soon as 2009 (it did not happen until 2015).
But the unprecedented shutdown and rapid re-opening of a $22 trillion economy makes for different recovery dynamics, one in which the Fed may not have to be as patient to tighten the spigot on its easy money policies.
“The updated views support our argument for higher rates in 2022, mainly that the market is not pricing enough policy tightening and will need to move more in line with the Fed's projections,” Deutsche Bank wrote in a note, adding that it also sees four rate hikes this year.
The nation’s top banker, JPMorgan Chase CEO Jamie Dimon, told CNBC Monday he could see the U.S. economy absorbing more than four rate hikes this year.
Powell, who looks poised to steer the central bank for the next four years after being renominated by President Joe Biden, has said the Fed will continue to watch the data on the economy’s progress on inflation and jobs.
“I wouldn’t look at it that we’re ‘behind the curve,'’’ Powell told reporters in December. “I would look at it that we’re actually in a position now to take the steps that we’ll need to take, in a thoughtful manner, to address all of the issues — including that of too-high inflation.”
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
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