The US Federal Reserve announced on 15^th December that it will move more quickly to end its economic stimulus, doubling the rate at which it winds down (or tapers) its asset purchase programme. This puts the Fed on track to stop buying bonds by March, and clears a path for it to raise interest rates shortly thereafter. Fed officials’ latest median projections indicate they may raise rates three times next year, and three more times in 2023.

Here are some top takeaways on the news and thoughts on the year ahead from Capital Group economist Darrell Spence and fixed income portfolio managers Ritchie Tuazon and Tim Ng.

1. Getting ready for rate hikes in 2022

Ritchie Tuazon and Tim Ng

The most important signal from speeding up the taper is that it opens the door to more 2022 rate hikes. But, while Fed policy changes are an inflection point that can rattle markets, it is important keep this news in perspective.

The Fed’s latest “dot plot” chart shows that most of its governors now anticipate three rate increases for 2022. This is big pivot from September, when only half of the members of the Federal Open Market Committee predicted rates would rise at all in 2022. It is also above market consensus of two hikes in 2022. Fed Chair Jerome Powell also indicated that the committee would start discussions on reducing the size of its balance sheet.

Now our base case is that the Fed will raise rates three times next year. Despite the hawkish tone of the announcement, stocks and TIPS did well after the announcement, and the yield curve steepened. If risk assets hold up and financial conditions remain loose, the Fed will have the green light to move even more aggressively to address inflation.

Near term rate hike expectations have risen due to high inflation¹

The 15^th December announcement also represents a hawkish shift from Powell, who was renominated by President Joe Biden in November for a second term. Powell had previously defended the view that the inflation we see today was “transitory” and would resolve itself, but he abandoned the term altogether in his statement this week.

In a press conference, Powell stated that November’s jobs report, which included upward revisions to prior jobs reports, coupled with November’s consumer price index (CPI) update, which showed a substantial increase to inflation, convinced him it was time to speed up the taper.

Powell noted that US labour force participation numbers are still “disappointing” but said that he believes the economy is still making rapid progress towardsmaximum employment. “We have to make policy now,” he said. “And inflation is well above target. So, this is something we need to take into account.”

The Fed appears to be interpreting the Omicron COVID-19 variant as an inflationary impulse but does not appear to be too concerned about its risks. Powell said that people are learning to live with the virus despite recurring waves, suggesting the economic implications may be limited.

1. Source: Federal Reserve. As at 15 December 2021.

 

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