Chart Of The Week   December 15 2021

FOMC Reinforces Powell’s Hawkish Pivot

hawkish fed

The FOMC delivered a hawkish message on December 15th. As expected, the central bank doubled the pace of asset purchase tapering, in effect bringing forward the end of the program to mid-March. Moreover, the median forecast for the fed funds rate now calls for three rate hikes in 2022.

This policy adjustment reflects changes to the FOMC’s economic expectations next year. Core inflation was revised up to 2.7% in 2022 from the prior estimate of 2.3%. Meanwhile, the projected unemployment rate was brought down to 3.5% in 2022 from 3.8% and the GDP growth outlook was increased to 4.0% from 3.8%.

During the press conference, Chair Powell downgraded the importance of rising labor force participation as a pre-condition for rate hikes. Powell cited the falling unemployment rate as evidence that the job market is “rapidly” approaching maximum employment and said that the Fed should strive for a “tight, but stable” labor market. The implication of that latter statement is that the Fed should act soon to curtail inflation in order to extend the employment market recovery for as long as possible.

The new FOMC projections suggest that the Fed is moving toward a June liftoff, and could possibly start hiking as early as March if inflation and inflation expectations move meaningfully higher. However, short-dated interest rates are already well priced for this outcome. The fed funds futures curve is fully priced for June liftoff and discounts a 46% chance of March liftoff. The major mis-pricing in US fixed income remains at the long-end of the Treasury curve, where yields are too low relative to the likely end-point for the policy rate.

US bond investors should keep portfolio duration below-benchmark and favor short-maturity (2-year) Treasuries over long-maturity (10-year) Treasuries.