Since bringing forward their liftoff forecast by “one full year” in late October, Goldman has regularly marked their Fed call to policy reality, alongside the Fed’s efforts to mark policy to the reality of persistently elevated US inflation.
Note that in this scenario, it’s not so much that Goldman (or any other bank) was behind the curve. Rather, the Fed was behind the curve, and so was market pricing, albeit to a lesser extent than policymakers. Over the last three months, policymakers, analysts and short rates rapidly adjusted, effectively acknowledging inflation’s intent to stick around, despite having worn out its welcome some time ago.
In the wake of the Jerome Powell’s somewhat laborious press conference, and considering the likely evolution of wage pressures and the read-through for inflation, Goldman now sees five hikes in 2022, with balance sheet rundown commencing in June (figure below).
“Chair Powell’s comments earlier this week… made it clear that the Fed leadership is open to a more aggressive pace of tightening,” Goldman’s David Mericle and Jan Hatzius said, noting Powell’s emphasis on the difference between this cycle and last, and his use of the word “steadily” to describe the likely pace of the Fed’s move away from accommodation. He “deliberately avoid[ed] the term ‘gradual’ that came to mean a quarterly pace of tightening last cycle,” Goldman remarked.
Mericle and Hatzius spent a considerable amount of time on Friday’s key wage and inflation data. They downplayed the cooler-than-expected headline ECI print, noting that private industry wages and salaries excluding incentive paid occupations “provides a less noisy” measure of the underlying trend. “Averaging across that measure and our composition-adjusted measure of average hourly earnings, wage growth now appears to have run close to 6% over the last half year,” they wrote.
Between that and still very elevated core PCE, Goldman raised their inflation forecasts. They now see core PCE at 2.9% at year end, from 2.5% previously. The figure (below) gives you a sense of things.
“Accounting for the lags in reporting the inflation numbers, our revised forecast implies that the latest available YoY core PCE and especially core CPI inflation rates at upcoming FOMC meetings will be very high for a while,” the bank remarked.
Goldman still doesn’t think 50bps in March is likely. “The market response to a 50bps hike is more unpredictable,” Mericle and Hatzius said, noting that the Fed hasn’t kicked off a hiking cycle with a 50bps hike “since the 80s.”
Nomura, on the other hand, now has 50bps penciled in for liftoff. “We believe Powell sent an unambiguous signal at [the] press conference that ‘this time is different’ with respect to the upcoming hiking cycle,” the bank’s Robert Dent said, calling Powell’s comments “the closest the Fed has come to admitting concern regarding being ‘behind the curve.'”
The figures (above) illustrate Nomura’s projections.
As far as how the US economy will cope with an aggressive Fed attempting to catch up, Nomura suggested tighter financial conditions will eventually weigh on activity.
“We continue to expect growth to slow sharply over the course of this year, and the Fed will likely become cautious when approaching the market-implied terminal rate of around 1.7% and their own wide 2-3% range of neutral rate estimates,” the bank remarked.
By that time, it’s very likely the curve(s) would be inverted. As one former president put it, the Fed will need to “Feel the market.”
Good man H. Appreciate the pieces as always. I was reading it thinking the whole time, “if this all comes to pass, how does the curve not invert?” And your closing captures it well.
Pondering on this a little more, keeping in mind the policy mistake that is clear and obvious (yet somehow everyone’s on board for it). It’s entirely possible/likely we’ve seen the peak on the long end for the intermediate term (10y yields at 1.92 this past week) and that by March the long end will be somewhere between 1.50-1.75. Based on current 2y yields (1.20), a .50 hike in March could immediately cause an inversion.
There’s a lot of forward looking data coming out this week, lower than consensus data will likely squeeze the 2s-10s further.
But hey, there should be an early week counter trend rally to sell into, so lets enjoy that.
“I feel the Market”…..and by end of year 2022 the brakes the Fed slams on via rate hikes & QT will be enough to stall economic growth. Inflation will still be nipping at Powell’s heels, then what?
Sell in May and go away inversion.
IBM set the tone this past week.
Weak link in inflation picture is China’s Covid policy.
Blizzard has me blabbering
China is in the dumps, now propping up it’s equity mkt, Germany entering 0 growth, Ukraine and the Fed is going to raise rates? GS is the official go to firm for the Fed to get their jawboning out. And it’s an election year. What may well happen is the Fed will lose credibility in a big way and mkts go on a wild ride looking to get away from a dollar with less and less purchasing power. Did you see that Bitcoin could be a national security problem and the answer is to have grandmother from the Bronx regulate it. How do you think that will go over with Gov Abbott?. Yet It is. You really want to hurt the US? Replace the world’s reserve currency in the world with Bitcoin. Note Russia’s position on it thise week and how Europe and the Mideast are moving closer to Crypto. The Fed is Web 2.0. HODL
The currency markets are acting basically in tandem. For crypto to have validity it would’ve acted as Gold in years past. This past week we would’ve seen value stocks suffering also and gold would’ve rallied big-time and we would have the big crash that Ancient Talking Heads have tea leafed.Coming out of a pandemic things are actually pretty good.
If you rolled up all the headlines the past month or two you would know that tech was going to get flogged.
No bubbles actually burst but some of the bigger puddles have evaporated a bit
I don’t understand why they are waiting till June. What is the driver for this delay? I know the Fed is supposed to be apolitical but if you consider that qJune balance sheet runoff times an economic recession with the midterms in November, it’s hard to argue that they are not acting politically. Especially in the absence of some explanation on what they are waiting for. This is still Trump’s Fed chief.
When you’re dealing with trillions of dollars, it’s not like an account transfer for regular people like us. It takes time, literally, to move that much money for the large institutions who need to provide the funds back to the Fed (loan repayments, required reserves, Basel III/Dodd-Frank/stress test requirements, etc). These institutions need to liquidate various holdings to meet their liquidity requirements/obligations.
Any sudden shift would likely cause financial systems to cease functioning adding greater supply-chain issues to the current logistical challenges. In the short term, it would likely spike inflation up as the supply chain became further stressed and dysfunctional, the opposite of the desired effect. Followed by significant economic destruction and possible depression.
Sure I’m not expecting that they offload 2 Trillion dollars tomorrow. But while they are waiting to stop asset purchases and then waiting 3 months to begin liquidating some of them, inflation remains high. This will drain bank accounts and ramp up credit usage just in time for the broke and debt burdened working class to get laid off.
The Fed knows that three hikes by June will risk yield curve flattening or inversion, absent move in long end. Powell committed to waiting one, or two, meetings before starting QT.
Either market forces move the long end very substantially in next few months, or Fed starts QT earlier (after March?) and targets long end, or Fed starts QT earlier and the knock-on effects of QT move the long end. Or, yield curve goes inverted.
I’m not sure how much consideration the “Fed starts QT earlier” options are getting.