Unlike market expectations, which have priced a Fed rate hike in mid-2022, we believe the Fed will look through inflationary pressures and hold off on hiking the federal funds rate until December 2022.
Market expectations for the federal funds rate
August 2021 versus November 2021
Source: Bloomberg, Principal Global Investors. Market expectations calculated using Fed Funds Futures. Data as of November 4, 2021.
In recent weeks, hawkish pivots from the Bank of England, the Bank of Canada, and the Reserve Bank of Australia have prompted markets to probe whether central banks really can look through elevated inflationary pressures. The global repricing of policy rate hikes hasn't bypassed the United States Federal Reserve (Fed) either. Markets now anticipate a Fed rate lift-off immediately after tapering concludes in mid-2022.
With supply chain issues likely to extend well into 2022 and an apparent broadening in inflationary pressures across the economy, elevated price pressures won't be brief, and Fed patience with inflation is likely wearing thin. The biggest concern, the risk that long-run inflation expectations become unanchored, may force the Fed's hand.
Yet, the mid-2022 market view still seems too early. Unlike other central banks, the Fed wants to see the labor market heal further, requiring the mystifyingly elusive recovery in labor participation to materialize before rate hikes commence. What's more, Chair Powell has repeatedly emphasized the separation between the end of tapering and rate hikes—there should be a few months interval between the two.
On balance, our expectation is for the Fed's first rate hike to come in December 2022. This will still be later than several other major central banks, with only the European Central Bank and the Bank Of Japan likely to out-patience the Fed.
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