From BBG economics
In the wake of the highest CPI reading since 1982 and several signs of a tight labor market, the FOMC (Wed.) is likely to take a sharp hawkish turn, both in the tone of the post-meeting press conference and in statement and forecasts. Faster taper — a doubling of the current pace — is most likely baked in. What might be more surprising — to the markets, not to us — would be how fast and high the Fed now wants to hike rates. We expect the dot plot will likely indicate three rate hikes next year, and the terminal rate to reach close to the Fed’s long-run neutral rate of 2.5%, substantially higher than what the market currently expects.
This likely steeper, higher projected rate-hike path might prompt critics to argue that the Fed is making a policy mistake, tightening just as inflation is finally proving to be transitory. Several data points would corroborate the view that inflationary pressure is easing, such as input price increases decelerating (PPI, Tues.; import price index, Wed.), inventories and production rising (industrial production; business inventories, Wed.), supply delivery delays improving (Empire manufacturing, Wed.). Commodity prices also have fallen in recent weeks.
But we think the Fed is doing the right thing. With the housing outlook still running hot (NAHB Housing Market Index, Wed.; housing starts, Thurs.) and the omicron variant potentially leading to another wave of supply-chain disruptions, the upside risk to inflation is still substantial. Rents could easily replace pandemic-related pressures as the driver of inflation next year.
And with consumption still solid (retail sales, Wed.), the labor market tightening (initial jobless claims, Thurs.), and businesses eager to invest on the back of strong profits (Philly Fed outlook, Thurs.), we expect — as the Fed likely does — that growth can withstand tighter monetary conditions. Indeed, monetary tightening is needed to ensure inflation expectations do not unanchor, allowing the expansion to continue and giving a chance for labor participation — a lagging indicator of employment conditions — to return to pre-pandemic levels. Viewed through that lens, a more hawkish Fed next week would not be abandoning its new monetary policy framework.
Wednesday, Dec. 15
We expect the FOMC to take a sharp hawkish turn at the upcoming meeting, both in tone and substance. With faster taper -- a doubling of the current pace -- almost a certainty, the meeting will provide further clues on two open questions: How fast will the Fed hike rates? And how high will they go?
On the former, the dot plot will likely indicate three rate hikes next year, as we and the Fed futures market currently expect. On the terminal rate, our read of the Fed’s reaction function is that they will likely revise up the path of policy rates beyond what the market is currently pricing. We think the market won’t like that.
Here’s what we will be looking for in next week’s FOMC:
An announcement doubling the pace of taper, from $15 billion to $30 billion per month, starting in January. The wind-down of asset purchases will be complete in mid-March.
Translating the retirement of “transitory” inflation into forecasts. Minutes from the last meeting show that staff still hang on to the idea that inflation will fall on its own in 2022, which is reflected in the median FOMC forecast that inflation will fall to 2.2%. We expect they will sharply revise up headline PCE for 2021 to above 5.0%, from 4.2% in the previous SEP, and the 2022 forecast to 2.5% from 2.2% prior.
The forecast for the unemployment rate will be revised down sharply. The November labor-market report showed unemployment at 4.2% in November, which is substantially lower than the 4.8% FOMC forecast for end-2021. The unemployment rate is likely to drop below 4% — the long-run unemployment rate according to the median FOMC — by March of next year. We expect the 2022 forecast to be revised down to 3.5% (vs 3.8% before). Further out, the unemployment rate forecast could stay at 3.5% or marginally lower.
Given these revisions, we think the Fed will forecast three hikes next year, followed by three to four in 2023 and three to four more in 2024. That would put the terminal rate at close to 2.5%.
One view among many (for some MORE see of the Sellside, see HERE)