Pro Perspectives 12/13/21

December 13, 2021

We have the big Fed meeting this week, which will conclude on Wednesday. 
 
Given the posturing by Jay Powell a couple of weeks ago at his congressional testimonies, we should expect the Fed to speed up the timeline on ending QE.
 
Remember, at the Fed's November meeting they projected an end of QE by June. 
 
The path to June came from their plan to taper bond purchases by $15 billion a month.  
 
If they decide on Wednesday to double those monthly cuts, we would then have a timeline to end QE by March
 
This matters because it's very, very unlikely that they would raise rates before ending the bond buying program.  With that being the case, the recent telegraphing from the Fed would suggest that March would be the earliest the Fed would begin the liftoff of interest rates.  
 
What does the interest rate market think?  The market is pricing in about a 30% chance of the March scenario, and about a 50% chance for a May liftoff. 
 
Now, with this in mind, remember on Friday we looked at the inflation spikes in 1973-1974, and the hot inflation of the early 80s.  In both periods, the Fed had to ratchet rates above the rate of inflation to finally get it under control.    
 
In the current case, they are nearly seven percentage points behind.  And if they aren't positioned to start raising interest rates (from the zero line) until March, at the earliest, the inflation situation is going to be left to only intensify.
 
Still, even if they begin an aggressive hiking campaign in March, with a 50 basis point hike, they will still be in a stimulative position for quite some time — which will continue to stoke inflation. 
 
If we look back at the past five tightening cycles by the Fed ('87, '94, '99, '04 and '15), the Fed has averaged about 50 bps a quarter. 
 
Keep in mind, the Fed will be tasked with bringing inflation under control, without killing the economic expansion.  Given the current position, it will be a tough task.  The trajectory looks like 2023 could be a tough year. 
 
The optimistic scenario, within the market, is driven by the idea that supply chain bottlenecks will be worked out, and naturally relieve inflation pressures.
 
The less optimistic scenario, while acknowledging the chance for a normalization on the supply side, we can't ignore the boom on the demand side, driven by $5 trillion of new money supply added over the past twenty months, a "reopening" economy, and hot job market.    
  

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