Pro Perspectives 12/15/21
December 15, 2021
This afternoon markets rallied following the Fed decision, where Jay Powell guided to a faster end of QE, and three rate hikes next year.
We expected that the Fed might double the cuts to its bond purchases. They did. We expected that the move would open the door to a rate liftoff as soon as March. It did.
While June remains the most probable month for liftoff, the Fed Chair indicated that they could liftoff when bond purchases are ended, which would be March.
On the face of it, this all sounds like a more hawkish Fed communication today than even expected.
But markets liked it. Why?
Because the Fed is forecasting a very shallow rate hiking cycle. That's because they remain arrogant enough to forecast an inflation rate that will reverse (from 7%) and land close to their 2% target, by next year.
With that, maybe the biggest message that markets came away with today: The Fed will not become inflation fighters.
Of course, that may or may not happen. But that was the takeaway today.
If you believe Jay Powell, you expect a hot economy to continue to strengthen, with a Fed that will perfectly thread the monetary policy needle, to produce just 2.6% inflation from a 4% growth economy (well above trend) at 3.5% unemployment (near record levels) — all while keeping the Fed Funds rate under 1% — and over the coming years, never needing to exceed the Fed's long-term target Fed funds rate of 2.5%.
That would be magic.
But remember, the Fed cares more about shaping expectations than they do about forecasting. They have a good record on the former, and a bad record on the latter. What matters most for markets, in the near term is the former. With that, markets go up today. And if we look back at the analogue of 2014, when the Fed was tapering its last round of QE, stocks went up. Only after the Fed actually made its first interest rate hike, in late 2015, did the path become tougher for risk assets.
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