This week it will take place the last fed’s meeting of the year, and as in previous meetings of the Federal Reserve, the financial industry is expectant to see what the Chair, Jerome Powell, has to say about tapering, inflation and interest taxes. As we did in the previous meetings, we wanted to know what are the thoughts of the professionals within the asset management management industry, so prior to this last meeting of the year we have put together some interesting insights on what to expect from fed.
Gilles Moëc, Chief Economist Axa IM
We think the picture is clearer on the Fed front. We expect the Fed to announce a quicker taper which would come to end by early Q2 2022, creating technical space to hike before the summer if need be, even if we don’t think Powell will elaborate on the latter point. In principle, as we discussed last week, the Omicron variant should be cause for pause, while the ongoing Covid wave is far from over – hospitalizations have started to rise again in the US (see Figure 3). But it seems the Fed partakes in the overall “higher tolerance to the sanitary risk” displayed in the US since the beginning of the pandemic. The inflation print for November – with yet another significant price push of key items such as rents – has probably solidified the central bank’s resolve to get ready for a pre-emptive tightening, even if we continue to think that a majority of the FOMC still expect inflation to decelerate significantly in 2022.
Gergely Majoros, member of the investment committee at Carmignac
While US and Europe central banks will make highly anticipated announcements later this week, soaring inflation is shaking up the way the monetary policy is conducted since the 2008 financial crisis. In other words, the real economy or the so-called main street could ultimately take the driving seat of the US Reserve federal (Fed) and European Central Bank (ECB) going forward after more than a decade of “unconventional measures” to support the global economy.
Over the recent weeks, long-term interest rates in Europe and US have moved significantly lower, which mainly reflect the outlook for a possibly steeper economic slowdown in 2022, amid fresh concerns about the latest Covid-19 variant Omicron. This downward movement has even accelerated as the recently re-nominated US Fed Chairman Jerome Powell has suddenly changed his tone on inflation into a more hawkish one and confirmed the need to tighten policy sooner than previously expected.
Due to rising prices, investors need to adapt to a new environment which shifted in less than a year from a “quantitative easing forever” and “lower for longer” interest rates situation to a context where a significant and global tightening of monetary policies is expected. Still, the recent developments call for a further and regionally differentiated analysis.
Regarding the respective monetary policies, we believe there is a good chance that the monetary environment in Europe will remain much more accommodating than in US.
The US economy seems much more resilient than the rest of the world, On the other hand, the outlook for inflation is also expected to be much more persistent in the US, mainly both by its tight labour market but also the far highest weight given to housing inflation.
In the US, an acceleration of the reduction of the Fed’s asset purchases is likely opening the path for interest rate hikes, potentially as soon as by mid-2022. Nevertheless, the current low levels of European rates encourage us to remain prudent here as well.
Christian Scherrmann, U.S. Economist at DWS
Fewer purchases expected The upcoming December FOMC meeting might turn out to be a pivotal point for U.S. monetary policy. Rhetoric by Fed officials prior the meeting clearly indicates the willingness to accelerate the pace of tapering and to maneuver monetary policy into place from where a wide range of possible outcomes can be addressed. Latest remarks by Fed Chair Powell during his testimony in Congress confirmed this willingness. While the Fed’s base case still might be that inflation rates normalize in the course of 2022, the risks to this outlook have increased materially and it seems like the Fed – for the time being – focuses entirely on the inflation leg of their dual mandate, also as price stability is now deemed a necessary condition to reach maximum employment. The emergence of a new variant of the Covid-Virus might support this stance as one possible implication of this situation could be another round of supply chain disruption and therefore accelerated inflation rates further into 2022.
Therefore, we now expect the FOMC to step-up the pace of tapering to USD 30bn per month, implying that the program will be concluded by end of Q1 2022. Further we expect that FOMC participants will indicate at least two rate hikes on median in their updated Summary of Economy Projections along with higher inflation rates for 2022 and 2023. This does not necessarily imply quickly following rate hikes after tapering is concluded. If inflation shows clear signs of easing in the first months into 2022, we still think the Fed is willing to wait with a lift-off of policy rates until maximum employment is achieved.
We think, however, that the definition of maximum employment will go through some evolution in the coming months, converging towards the post-pandemic reality that is shaped by a lower participation rate and higher wages. This new version of maximum employment, however, could well be achieved by mid- 2022. Overall, for now, we remain with our base-case of one rate hike in the second half of 2022 as we expect inflation rates to recede in the first half of 2022 what gives the Fed the opportunity to further support employment for a while. But at the same time, we highlight the increased probability of two hikes with a lift-off most likely in mid-2022.
Stéphane Déo, Head of Market Strategy, Axel Botte, Global Strategist, Zouhoure Bousbih, Emerging Countries Strategist and Aline Goupil-Raguénès, Developed Countries Strategist at Ostrum AM
The EQ is 120 Bn per month, the tapering starts at the end of November with 15 Bn per month. That is 8 months to exit QE, and therefore a QE that ends at the end of June. The forecast, after several statements, including Powell’s, is for an acceleration of the tapering. An acceleration to 20 Bn would complete the QE in 6 months, i.e. in April.
In terms of rate hikes, the curve has changed significantly since the summer, particularly with a clear tightening of the Fed’s communication. The markets are expecting Fed funds at 0.70% at the end of 2022, i.e. two rate hikes and possibly a third; and Fed funds at 1.345% at the end of 2023, i.e. five rate hikes over the two years, possibly a sixth.
The Fed’s communication has gradually evolved towards a more restrictive attitude. This was the case during the June and September FOMC meetings, which both surprised the markets. This has also been the case for several weeks, especially with Powell saying that inflation is not “temporary” and that tapering could be accelerated.
As for economic data, inflation persists at 6%, the unemployment rate, if it continues to fall, would be below 3.5% (pre-Covid low) by March next year, and the surge in the property market is undeniable, with strong pressure on prices in particular. Finally, the valuations of financial assets in certain markets are very tight.
Conversely, the risks related to the resurgence of covid are a short-term bearish hazard for the activity. On the other hand, if the disruption is limited in time it will ultimately result in more disruptions in supply chains and therefore more inflation in the long run. It therefore seems clear that the ultra-loose policy put in place at the worst moment of the pandemic in March last year is no longer appropriate and that a gradual normalisation is needed.
Conclusion: We are still expecting a tapering of 15 billion per month and therefore an end in June next year. The very low level of rates may indeed encourage the Fed to accelerate the move as did the Bank of Canada.
In terms of rate hikes, with QE ending in June at the latest, it is therefore very likely that the Fed will initiate its rate hike cycle before the end of 2022. However, the three rate hikes that the market was expecting seem excessive.
Seema Shah, Chief Strategist at Principal Global Investors
According to last week’s CPI readings, inflation is now at the highest level in almost four decades. Consumer demand is red hot, supply chain problems persist, and energy costs have jumped. Shortages in many sectors remain, especially among semiconductors and the vehicle industry. Near-term uncertainties around the Omicron COVID variant and the on-going global shipping problems could worsen inflation in the near-term before pricing pressures begin to improve.
Perhaps the most significant impact for investors of faster inflation is its effect on Federal Reserve (Fed) policy. Chair Jerome Powell, in recent testimony to Congress, has given up the term “transitory” when describing inflation trends.1 While the Fed may still believe that inflation is due to the one-time effects of the pandemic and supply chain problems, they are no longer suggesting that these issues will be resolved quickly.
As a result, the Fed is set to announce a faster taper process as early as its December 15 meeting. This could pave the way for a faster rate hike timeline in 2022 with liftoff occurring in Q2. With this shift in policy, we now anticipate 4 to 6 rate hikes over the course of 2022 and 2023. Although this change in the timeline drove some volatility over the past two weeks, markets appear to have stabilized and digested this news.
As inflation rises, it is still the case that equity valuations continue to hover near their highs and credit spreads remain tight. Companies with pricing power and balance sheet strength are attractive in these periods and further highlight the case for large/mega cap tech. We also continue to prefer shorter-duration bonds, as rates steadily rise from low levels, as well as REITs, which can be a natural hedge against inflation and can provide income while rates are still low.