Fed May Have Just Two Hikes Left, SocGen Quant Suggests
Market pricing for Fed hikes went into overdrive late last week, when tail hedges for 75bps hike increments showed up on radar screens.
The dramatic escalation in rates suggested traders aren’t convinced the front-end selloff has run its course, nor are they convinced enough rate hike premium is built in.
But to say some are skeptical of the economy's capacity to absorb ~250bps of hikes in 2022 alongside the tightening impulse from balance sheet runoff would be an understatement. The advanc
If the Fed is going to be “data driven” rather than “model driven”, and tightening’s economic effects will show up in “data” with a lag, then a policy overshoot seems likely.
Suppose you’re the Fed. Your #1 priority is to Whip! Inflation! Now! You’re not particularly concerned if investors give up some of 2020-2021’s windfall gains. You would be concerned about sinking the job market or a financial crisis, but the job market is still very hot and you’ve lots of experience at stopping financial crises. Your biggest fear is that high inflation gets deeply embedded in the economy, a la 1970s-1980s. You don’t see an imminent end to global supply disruptions. The government is in full midterm election paralysis mode and will probably next be in full gridlock mode, no help coming here.
Wouldn’t you err on the side of doing too much with your tools, rather than too little?
Also: do you want to walk into the next recession with only 80 bp of policy rate to ease?
Raising rates so you have dry powder in a recession is not usually good policy. Better to not raise in the first place if that is going to push you into a recession. The Fed needs to adjust rates and possibly (not my preferred choice but theirs) the size of the balance sheet. Just not as much as hawks want.
This is why I think need to think about what “sort” of recession it will be.
I think Fed is willing to push economy into a recession if that is what is needed to get inflation under control. Especially if it believes recession is likely to be shallow, short, even “technical”. I also think Fed is willing to push market into a bear.
Basically, a recession is bad but not a disaster, while letting the economy slide into 1970s-style inflation would be a big disaster – from the point of view of the Fed, both the people and the institution. And a bear market, if orderly, is not necessarily bad at all – again, from the point of view of the Fed.
So – again, just my view – when betting on what the Fed will or won’t do, assuming that it will try hard to avoid pushing economy into a recession is not a safe bet.
The risk of China shutting down is rising. That would create severe inflationary pressures, forcing more hikes than currently anticipated. Take your pick.
I’m not in charge of anything but I know enough to look harder at the PPI. That’s where the faltering supply chain is most visible. I still don’t believe that raising rates will fix the supply chain disaster and even though there is a lag between PPI and CPI, unless the supply chain gets fixed properly, prices will keep rising — unless, of course, the Fed really does want to put main street in a huge hole. The last big scary hole occurred just two years ago and cost, what, 6 or 8 trillion? We can’t do that again anytime soon.
The supply chain is definitely impacting the US. China’s pandemic policy, though we’re now in an endemic phase, is part of the problem. Thank you, Xi Jinping. And it’s a small world. Few options are available to change and/or the fix supply chain.