Federal Reserve Chairman Jerome Powell testifies during the House Financial Services Committee hearing titled Treasury Department and Federal Reserve Pandemic Response Watch at Rayburn Building on Wednesday, December 1, 2021 .
Tom Williams | CQ-Roll Call, Inc. | Getty Images
Persistent high inflation combined with a labor market close to full employment will push the Federal Reserve to raise interest rates more than expected this year, according to the latest forecast from Goldman Sachs.
The Wall Street firm’s chief economist Jan Hatzius said in a note on Sunday that he now expects the Fed to enact four quarter-percentage-point rate hikes in 2022, which is one way even more aggressive than the Fed’s guidance just a month ago. The Fed’s benchmark overnight borrowing rate is currently pegged in a range of 0% to 0.25%, more recently about 0.08%.
“The weaker labor market slowdown has made Fed officials more sensitive to the risks of upward inflation and less sensitive to the risks of downward growth,” Hatzius wrote. “We continue to see increases in March, June and September, and have now added an increase in December for a total of four in 2022.”
Goldman had previously forecast three hikes, in line with the level Fed officials said after their December meeting.
The company’s outlook for a more hawkish Fed comes just days before key inflation readings this week, which should show prices are rising at their fastest pace in nearly 40 years. If the Dow Jones estimate of 7.1% year-over-year growth in the consumer price index is correct, it would be the biggest gain since June 1982. This figure is expected on Wednesday .
At the same time, Hatzius and other economists don’t expect the Fed to be deterred by the decline in job growth.
Non-farm payrolls rose 199,000 in December, well below the estimate of 422,000 and the second consecutive month of a report well below consensus. However, the unemployment rate fell to 3.9% at a time when job openings far outnumber those looking for work, reflecting a rapidly tightening labor market.
Hatzius believes these converging factors will cause the Fed not only to raise rates by a full percentage point, or 100 basis points, this year, but also to start shrinking its balance sheet size by $ 8.8 trillion. . He specifically pointed to a statement last week from San Francisco Fed Chairman Mary Daly who said she could see the Fed start to ditch some assets after the first or second hike.
“We are therefore advancing our runoff forecast from December to July, with even earlier risks,” Hatzius wrote. “With inflation likely still well above target at this point, we no longer think the start of the runoff will substitute for a quarterly rate hike.”
Until a few months ago, the Fed was buying $ 120 billion a month in treasury bills and mortgage-backed securities. Starting in January, these purchases are split in half and should be completely phased out in March.
Asset purchases helped keep interest rates low and keep financial markets functioning well, supporting an almost 27% gain in the S&P 500 for 2021.
The Fed will most likely allow a passive flow of the balance sheet, allowing some of the proceeds from its maturing bonds to flow out each month while reinvesting the rest. The process has been dubbed “quantitative tightening,” or the opposite of quantitative easing used to describe the massive expansion in the balance sheet over the past two years.
Goldman’s forecast is in line with market prices, which project an almost 80% chance of the first pandemic-era rate hike in March and a near 50-50 chance of a fourth increase by December. , according to CME. FedWatch Tool. Federal funds futures traders even see a sizable 22.7% chance of a fifth hike this year.
Yet markets are only seeing the fund rate rise to 2.04% by the end of 2026, below the peak of 2.5% reached in the most recent tightening cycle that ended in 2018.
Markets reacted to the prospect of a Fed tightening as government bond yields soar. The benchmark 10-year Treasury note recently fell around 1.77%, almost 30 basis points higher than a month ago.