Andrew Pyle
December 16, 2021
Federal Reserve sets the stage for rate hikes
The Federal Reserve FOMC met for the last time of the year today and the level of investor interest was heightened as this was seen as an opportunity for the Fed to lay out the course of action for 2022. Most anticipated that the Fed would accelerate the pace of bond purchase tapering and they delivered on that - cutting purchases by $30 billion per month. Unless something comes out of left field, the Fed will be on target to be completely done with quantitative easing by March of next year.
Ending bond purchases was a pre-requirement before any hike in interest rates, so the Fed has opened the door to start that process in the second quarter of 2022. The Fed's own consensus forecasts for rates is for three increases next year. This is a little above what market participants expected, but the Fed only sees three more rate hikes in 2023 and that is not a hawkish shift to be honest. In other words, if you believe that we ultimately get six rate hikes in two years, that puts the Fed target rate at only 1.75% by the end of 2023. I would argue that the market is comfortable with that and we see that in terms of the knee-jerk lift in stocks after the announcement.
A couple of takeaways. First, this Goldilocks view to rate hikes (not too little, not too much) implies a sanguine environment for inflation and a continued economic recovery through 2023. Inflation is expected to drop to 2.6% in 2022 and 2.3% in 2023. The average would be above the Fed's target, however, so anything that suggests inflation will track above these forecasts will probably lead to more than three hikes next year. Second, there is also a sense that the Fed will remain cautious with respect to COVID-19 and that it will stay data dependent.