Goldman joined the ranks of those predicting four Fed hikes in 2022, as Wall Street continued to mark their FOMC calls to policy reality, just as the Committee was forced to mark policy to inflation reality.
Jan Hatzius cited the December minutes and subsequent remarks from Mary Daly in pulling forward the bank’s timeline on balance sheet runoff to July (from Q4) and adding a hike in December. Hatzius suggested QT might commence even earlier.
“With inflation probably still far above target [in July], we no longer think that the start to runoff will substitute for a quarterly rate hike,” he said, in a note dated January 9.
Read more: Fed’s ‘Remarkable Turn’ Puts Big Red Circle Around March
Notably, Goldman still thinks market pricing for the longer-run funds rate is far too low. Hatzius cited the same supply-demand imbalance the bank’s US rates team discussed last week, as well as “an extremely low market estimate of nominal r*.”
“We think both play a role, but neither is likely to keep the funds rate from ultimately rising well above the 1.6% now discounted in market pricing,” he said, adding that “nominal r* is probably higher than in the last cycle” due to bigger deficits and the Fed’s modified approach to inflation which, you may have noticed, is working. They said they’d countenance overshoots in the interest of ensuring US consumers didn’t succumb to a deflationary mindset. Mission accomplished.
Hatzius went on to say that the supply-demand imbalance should eventually favor higher rates once the Fed and its peers get on with shrinking their balance sheets, while the legacy of pandemic fiscal policy will linger in wider government deficits. The figure on the left (below) is self-explanatory.
On the right (above) are updated charts on Omicron, which together suggest both South Africa and the UK are past the peak.
Goldman weighed in on that. “Both confirmed cases and hospital admissions are now on a downward trend not only in South Africa but also in London, the first place in the Northern Hemisphere to see a major outbreak,” the bank said, adding that if the observed pattern “holds up elsewhere, the economic impact should be largely behind us by the end of Q1, at least in the advanced economies.”
One lesson from Omicron seems to be that when policymakers are confronted with the highest inflation in four decades, they’re prone to interpreting all developments as inflationary. Omicron, for example, was either going to get worse, prolonging supply chain disruptions and labor market frictions, contributing to persistently elevated input prices and labor shortages, or it was going to get better, clearing the path for stronger growth. Inflation either way.
In any case, the title of Goldman’s note was straight to the point: “Earlier Runoff, Four Hikes.”
With the consensus now 4 (or more!) rate hikes in 2022 and QT starting by mid-year or earlier, COMP at the 200 dy, IWM at a support level, feels like a local bounce point . . .
Actual qt led to lower UST bond rates. Go back and look. 4 hikes and a shrinking balance sheet will likely prove to be aspirational for the FOMC. The modern developed world is way too leveraged to tolerate a rapid fading of monetary stimulus. We could get there eventually but not as fast as the hawks are projecting. As far as the virus is concerned a peaking omicron is the base case, but there is always the risk of variants. Economic growth rates have peaked and if the FOMC and the other central banks are not careful and deliberate on exiting loose policy there is an accident waiting to happen- tightening right into a slowdown. The ghost of Wim Duesenberg….
@jyl – nice bounce call there.
@RIA – I am in the midst of writing a client letter. I’ve been thinking of saying something like “we’re moving from transitory inflation to aspirational rate hikes.” Great minds think alike! Well, some minds do or never mind.
@RIA I agree, both in the risk of policy error and the risk that Omicron is not in fact the “end of Covid”. However, I think both are inescapable.
I think the Fed is boxed into a corner. What data would allow it to NOT start liftoff + QT in 1H22 without losing credibility?
As for Covid, with ~3MM new cases/day, new mutations are surging, eventually some new variant will emerge, and whether it is more or less “virulent” is just luck.
Yes, indeed, the Fed’s modified approach to inflation. They were holding a tranquilized tiger by the tail for 10+ years, while they taught it to do tricks. But now it’s showtime and the tranquilizer’s are wearing off. “Watch!” cried the ring master, “As I loosen my grip just a bit, the tiger will start to do yoga. And when I loosen it a bit more, he shall dance a tango with me!”.
“Ah, here he’s awakening. I shall now demonstra….”