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January 25, 2022: -According to a Goldman Sachs analysis, Accelerating inflation could cause the Federal Reserve to get even more aggressive than economists expect in the way it increases interest rates this year.
With the market expecting four quarter-percentage-point hikes this year, Goldman economist David Mericle said the omicron spread aggravates price increases and could push the Fed into faster rate increases.
“Our baseline forecast calls for four hikes in March, June, September, and December,” Mericle said in a Saturday note to clients. “But we see a risk that they will want to take some tightening action at every meeting until the inflation picture changes.”
The report came just a few days before the policymaking group’s two-day meeting starting on Tuesday.
Markets do not expect any action regarding interest rates following the gathering but do figure the committee will tee up a hike coming in March. If that happens, it will be the initial increase in the central bank’s benchmark rate since December 2018.
Increasing interest rates would be a way to head off spiking inflation, which runs at its highest 12-month speed in almost 40 years.
Mericle said that economic complications from the Covid spread had aggravated imbalances between booming demand and constrained supplies. Secondly, wage growth continues to run at high levels, particularly at lower-paying jobs, even though enhanced unemployment benefits have expired and the labor market should have loosened up.
“We see a risk that the FOMC will want to take few tightening actions at every meeting until that picture changes,” Mericle wrote. “This raises the possibility of a hike or an earlier balance sheet announcement in May, and of more than four hikes this year,” Mericle added.
According to CME data, traders are pricing in almost a 95% chance of a rate increase at the March meeting and an over 85% chance of four moves in all of 2022.
However, the market is also starting to tilt to a fifth hike this year, which would be the most aggressive Fed that investors have seen going back to the turn of the century and the efforts to tamp down the dot-com bubble. Chances of a fifth-rate increase have moved to almost 60%, according to the CME’s FedWatch gauge.
In addition to hiking rates, the Fed is winding down its monthly bond-buying program, with March as the current date to end an effort that has over doubled the central bank balance sheet to just shy of $9 trillion. While few market participants have speculated that the Fed could shut down the program at the coming week’s meeting, Goldman does not expect that to happen.
The Fed could, though, provide more indication regarding when it will start unwinding its bond holdings.
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