Federal Reserve Chairman Jerome Powell testifies during the House Financial Services Committee hearing titled Oversight of the Treasury Department and Federal Reserve’s Pandemic Response, in the Rayburn Building on Wednesday, Dec. 1 2021.
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Continued 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 believes the Fed will adopt four quarter-percentage-point rate hikes in 2022, representing a trajectory even more aggressively than central bank guidance from just a month ago. The Fed’s benchmark overnight borrowing rate is currently anchored in a range between 0% and 0.25%, most recently around 0.08%.
“The labor market slowdown has made Fed officials more sensitive to upside inflation risks and less sensitive to downside growth risks,” Hatzius wrote. “We continue to see increases in March, June and September, and have now added one increase in December for a total of four in 2022.”
Goldman previously forecast three hikes, in line with the level Fed officials penciled in after their December meeting.
The company’s outlook for a more hawkish Fed comes just days before key inflation numbers this week are expected to show prices rising at their fastest pace in nearly 40 years. If the Dow Jones estimate of 7.1% year-over-year consumer price index growth in December is correct, it would be the largest gain since June 1982. That figure is due out on Wednesday.
At the same time, Hatzius and other economists don’t expect the Fed to be discouraged by declining job growth.
Nonfarm payrolls rose by 199,000 in December, well below the 422,000 estimate and the second straight month of a report well below consensus. However, the unemployment rate fell to 3.9% at a time when job openings far exceeded the number of people looking for work, reflecting a rapid tightening in the job market.
Hatzius believes these converging factors will cause the Fed to not only raise rates by a full percentage point, or 100 basis points, this year, but also begin to shrink the size of its $8.8 trillion balance sheet. . He specifically pointed to a statement last week from San Francisco Fed President Mary Daly who said she could see the Fed start shedding 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 believe the onset of the trickle down will substitute for a quarterly rate hike.”
Until a few months ago, the Fed was buying $120 billion a month in Treasuries and mortgage-backed securities. Starting in January, these purchases are halved and should be completely phased out in March.
Asset purchases have helped keep interest rates low and financial markets functioning well, supporting a nearly 27% gain in the S&P 500 for 2021.
The Fed will most likely allow passive runoff from the balance sheet, allowing a portion of the proceeds from its maturing bonds to roll over each month while reinvesting the rest. The process has been dubbed “quantitative tightening,” or the opposite of quantitative easing used to describe the massive balance sheet expansion of the past two years.
Goldman’s forecast is in line with market prices, which predict a nearly 80% chance of the first pandemic-era rate hike in March and a near 50-50 chance of a fourth hike by December. , according to the WEC. FedWatch Tool. Fed funds futures traders even see a sizable 22.7% chance of a fifth hike this year.
Yet markets only see the funds rate rising to 2.04% by the end of 2026, below the peak of 2.5% reached in the last tightening cycle that ended in 2018.
Markets reacted to the prospect of Fed tightening, with government bond yields soaring higher. The benchmark 10-year treasury recently yielded around 1.77%, nearly 30 basis points higher than a month ago.