Goldman Sachs hints at more aggressive Fed rate hikes in 2022...

Christopher Joye

Coolabah Capital

In a research note over the weekend, Goldman Sachs chief economist Jan Hatzius wrote that while they expect the Fed to lift rates four times in 2022, the risks are increasingly skewed towards a more aggressive hiking profile:

Two recent developments have made us more concerned about the inflation outlook. First, Omicron could prolong supply-demand imbalances and delay price normalization in the goods sector. Second, wage growth is still running at a 5-6% annualized pace months after enhanced unemployment benefits expired. In coming months, the inflation dashboard is likely to show lingering supply chain problems, hot wage growth, strong rent growth, very high year-on-year core PCE and especially core CPI inflation, and very high short-term inflation expectations.

The hammer from GS was the spectre of consecutive interest rate hikes from the Fed month-after-month, which could easily total more than four this year. We've certainly argued for 6-7 hikes from the Fed this year, and a slow start from the RBA in late 2022 with perhaps only one or two hikes, subject to Martin Place getting its triple crown of circa 3% wages growth, a 3-handle on the jobless rate, and core inflation trending up towards 3%. This is what GS wrote on the weekend about the possibility of a faster pace of Fed hikes:

We see a risk that the FOMC will want to take some tightening action at every meeting until that picture changes. This raises the possibility of a hike or an earlier balance sheet announcement in May, and of more than four hikes this year. The limited tightening in financial conditions so far, if sustained, would lower the bar for hiking more than the four times the market has already priced. If Fed officials do decide that they need to be more aggressive, they would likely hike by 25bp at consecutive meetings rather than hike by 50bp. Even that would be a major step, and few Fed officials appear to be considering it for now.
We have revised our Fed scenario analysis to reflect this possibility of faster rate hikes in response to higher inflation. The probabilities we assign to possible paths for the funds rate imply that the risks are tilted somewhat to the upside of our baseline and that our views remain more hawkish than market pricing.
Balance sheet reduction is likely to be quicker than last cycle, mainly because there is much further to go. We expect peak runoff caps of $60bn per month for Treasury securities and $40bn per month for mortgage-backed securities, or $100bn total, with at most a brief ramp-up period. We project that this would shrink the balance sheet from $8.8tn today to $6.1-6.6tn over 2-2.5 years. Our analysis implies that this amount of balance sheet reduction would raise 10y Treasury yields by 30bp, though some of this is likely already priced, and would have roughly the same impact on the economy as a 30bp rate hike.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 26 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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