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Fed outlook: faster tapering, earlier rate hikes

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Tapering

Fed outlook: faster tapering, earlier rate hikes

Dec 9, 2021

We have changed our view on the Fed's likely policy path. As recent inflation readings have been higher than expected, more Fed members have been taking a hawkish tone. And improvement in the labour market means that the Fed is getting closer to the second aspect of its mandate – full employment. So we expect the tapering of bond purchases to go faster, which also allows earlier rate hikes. We believe the Fed will hike policy rates by 0.25 per cent in June 2022, September 2022, March 2023 and September 2023. We discuss the market implications, but note that the market already prices in at least as many rate hikes.

  • The Fed has a dual mandate of price stability and maximum sustainable employment, and in their recent policy discussions, they stated that they would keep Fed funds unchanged until 1) inflation has risen to 2 per cent and is on track to exceed 2 per cent for some time, and 2) labour market conditions have reached levels consistent with its assessment of maximum employment
  • The first condition for rate hikes has clearly been fulfilled (and exceeded) for some time. But unemployment has so far remained too high to satisfy the second condition. This may soon change and allow the Fed to take a more hawkish tone, as we have already seen from several Fed members' speeches. The strong labour market figures last month, and the strong expectations for non-farm Payrolls later this week (550 thousands) suggest a change in policy could be imminent. In September, the committee was evenly split on the whether rate hikes are appropriate before December 2022, and given recent labour and CPI data, we think the balance will now be tilted in favour of rate hikes starting in 2022
  • As a first step, we think the Fed will start to double the pace of its tapering from December (from 15 billions to 30 billions per month), which would mean bond purchases would end in March 22. That should allow them to start hiking interest rates in June 2022. In the course of H1, they may also start to discuss shrinking the balance sheet and they could start actively selling bonds by the end of 2022
  • We note that the market already prices in 2 hikes in 2022, and our 2023 assumptions are also close to the market's expectations. Hence, we do not change our investment strategy, but think volatility will help quality stocks, the US dollar and hedge funds

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