Fed’s Rate Hike Cycle Expected to Start in 2H22
The authors are economists of Shinhan Investment Corp. They can be reached at chee@shinhan.com. – Ed.
2022 outlook for US monetary policy: 1) Lower inflation in 1H vs. higher 2H
One of the key issues in the financial markets lately has been an early tightening of monetary policy in the US. We looked into the Fed’s major policy objectives to predict its monetary choices next year. First, the US Consumer Price Index (CPI) is expected to peak at the year-end or early 2022, and slow down to 3-4% levels in 1H22 with effects of supply chain disruptions and high energy prices easing. The Fed is likely to start raising interest rates in 2H22 as higher wages should trigger demand-pull inflation.
2) Job recovery in 2H, 3) neutral financial conditions, 4) fiscal deleveraging
Second, we believe the labor market recovery that is expected in 2H22 will not be enough to raise interest rates. The US appears to be near full employment with the jobless rate down to the 4% range. However, past patterns show that the Fed raised rates about a year after employment returned to pre-crisis levels.
Third, liquidity and credit indicators, which are barometers of financial market conditions, are forecast to remain stable. It should be noted that the government’s liquidity and credit support is still in place.
Fourth, the Fed has been calling for more fiscal stimulus since the COVID-19 pandemic broke out. Faster tapering of asset purchases is likely to create a supply-demand imbalance in US Treasuries. Rate rise decisions will take into account long-term yield levels as the Fed is behind the government’s deleveraging efforts. We project three or four rate increases through 2023 considering the spread between short- and long-term Treasury yields during past rate hike cycles.
Fed’s rate hike cycle to start in 2H22
Taken together, the Fed is forecast to raise interest rates once or twice in 2H22 rather than 1H22. The tightening cycle will start in 2022, but we expect accommodative liquidity environment to continue given the Fed’s estimate of a neutral rate of 2.5%.