This is arguably one of the biggest questions in the market this year. The Fed is definitely going to hike rates, but how many times?
The general consensus seems to be three rate hikes at least (one every quarter starting from March) but lately we’re seeing more and more calls for four rate hikes (additional one in December).
So, what gives?
The story here is all about catching up to surging inflation pressures in the wake of the economic recovery. The fear for the Fed is that they may be facing stagflation or hyperinflation risks, though I’d still argue those are a bit more overblown. That is not to say that there won’t be dangerous times coming though.
However, as much as the Fed has to step in, they’re not the best suited in dealing with rising price pressures in the US and globally for that matter. A lot of this inflation rhetoric stems from supply bottlenecks and capacity constraints – something that monetary policy isn’t going to help resolve whatsoever.
Sure, the Fed will try to do their part but they can only do so much.
Taking that into consideration, the key risk to the inflation debate instead is actually China. We’ve gone into plenty of details in our other posts and you can check that out here. But the gist of it is, the Fed outlook may very well be an outlook that has to account heavily on the pandemic and the situation in China.
The tightening cycle in 2016-2018 hit a snag in 2019 and one can argue that any terminal rate (in dealing with inflation only) this time around would be at a much lower threshold. As such, does the Fed want to go all guns blazing or do they want to take a more prudent approach?
History would suggest the Fed has a proclivity to lean towards the latter and even though they did rush to switch from ‘transitory’ to ‘we must hike rates now’, I don’t expect policymakers to be too gung ho once we get liftoff.
Four rate hikes may not be out of the question this year but if anything else, that sets up a benchmark for probable disappointment if policymakers fail to convince in the months ahead.
That will be something to be wary about when considering the Fed outlook this year. But again, a lot of which will come down to the general inflation outlook so keep a watchful eye on that.