‘By One Full Year’: Goldman Shifts Fed Call Dramatically

One day, we may look back on the last several weeks and chuckle at the idea that a sea change was afoot.

After all, monetary policy will still be relatively accommodative even if there is a coordinated attempt to tighten at the margins. And if central banks can just buy a few months, supply chains may begin to normalize in earnest, easing price pressures, while higher wages and better benefits coax workers from the sidelines, alleviating the labor shortage.

At that point, some of the urgency to deploy aggressive, preemptive rate hikes would abate, making this month’s short-end drama appear as a tempest in a teapot in hindsight.

Wishful thinking? Maybe. And, for now at least, we’re left to summon our best hyperbole — like “bloody” and “napalm” — to describe a statistically anomalous front-end fracas.

Read more: Napalm

Analysts, meanwhile, have little choice but to adjust their forecasts. Just ask anyone who covers the RBA and spent last week watching the yield on the YCC note surge to eight times the target.

In one of the more notable such adjustments, Goldman pulled forward their Fed liftoff call to July of 2022. That isn’t a “tweak.” It’s a substantial shift.

“We are pulling forward our forecast for the Fed’s first rate hike by one full year,” the bank’s Jan Hatzius and David Mericle said, in a Friday note. “We expect a second hike in November 2022 and two hikes per year after that,” they added, before emphasizing that “the range of possible outcomes is wide, especially in the longer term.”

It’s now clear that the Fed intends to complete the taper by June (figure below). Barring a surprise, a $15 billion month reduction in monthly asset purchases will be announced next week.

Although Goldman noted that “large surprises on the virus, inflation, wage growth or inflation expectations” could conceivably compel the Fed to revise the pace, the bank said that in their view, “the hurdle for a change in either direction is high.”

Driving the decision to pull forward liftoff is an assumption that core PCE will stick above 3% and core CPI above 4% when the taper ends. The bank cited supply chain disruptions.

Hatzius wrote that although “sequential core inflation should be lower at that point, assuming that both goods demand and supply constraints have started to ease, it will still be around 2% annualized, with the trending shelter component running hot.”

Remember, critics of the transitory narrative have, for months, emphasized that the surge in housing prices will eventually find its way into measured inflation (figure below).

Of course, if you’re trying to rent or buy (and as far as I’m aware, those are the only two options for obtaining shelter), you’re feeling the squeeze already.

As for employment, Goldman sees the U3 rate at 3.7% by the time the taper concludes. Although the bank conceded that the participation rate may still be below pre-pandemic levels, Hatzius wrote that, “with inflation far above target, unemployment at 3.7% and job availability high — very different circumstances from those after the financial crisis, when participation fell as workers exited the labor force after years of fruitless job search — we think the committee will conclude that most if not all of the remaining weakness in participation is structural or voluntary.”

Although some dovish members could conceivably contend that the Fed has failed to foster a more inclusive labor market in line with the tweaked language around the employment mandate, any protestations won’t be enough to deter a hike, according to Goldman.

Hatzius and Mericle also addressed the possibility that a handful of small rate hikes might be insufficient or, considering the nature of current price pressures, simply ineffective, at bringing down inflation.

“We are often asked whether a couple of 25bps rate hikes will really be enough to soften demand and bring inflation under control,” they wrote, before answering as follows:

The answer is that we do not expect monetary policy to do the bulk of the work. The large, steady decline in the level of fiscal support through the end of next year will provide the great majority of the policy tightening that should eventually slow growth to trend, once near-term boosts from further reopening, restocking and spending of pent-up savings diminish.

The problem is, none of this really gets at the real issue — namely, supply chain disruptions as manifested in, most dramatically, traffic jams at crucial container ports.

Goldman addressed that as best they could, but the implicit question (i.e., “How long will it take to restore a sense of normalcy to a globalized world after a deadly virus kills five million people in less than two years and forever alters the way we think about sourcing, producing and spending?”) is obviously unanswerable.