Despite Ukraine, Markets Still See Aggressive Fed Action This Year

When the Fed meet next week, it’s highly likely in the eyes of the both the bond markets and recent statements from Fed policymakers that rates rise. However, the prospect of a 50bps move that was suggested earlier this year is now largely off the table. However, looking beyond that, the market sees aggressive rate increased in 2022, perhaps more so than before the Ukraine invasion began.

Commodity Spike

A lot has changed, Russia’s invasion of Ukraine has, in part, pushed global stock markets generally lower and various commodities including energy and, notably, wheat far higher.

Inflationary Pressures

If anything inflation may increase further for 2022 as higher energy and other prices, if sustained, could feed into many other goods and services. That puts the Fed in a tricky position. Yes, geopolitical tensions may have increased risk and disrupted supply chains. That and higher gas prices hurting consumer’s wallets would make the Fed typically a little more cautious on rate hikes.

However, inflation may be trending higher still, in part because of these events, and the Fed has a mandate to keep inflation under control. At over 7%, it’s not currently. Recession presents a mild risk too, according to some indicators, but the yield curve is not inverted, if somewhat flatter than previously. It’s a difficult balancing act for the Fed.

More Hikes Expected

Despite the Ukraine invasion, the bond markets actually see arguably more aggressive Fed action in 2022, than they did just a month ago according to the CME’s FedWatch Tool. Broadly speaking the bond market implies that we’ll likely see between four and eight hikes by the Fed’s December 2022 meeting as the most likely set of potential outcomes. Of course, that’s a broad forecast and the Fed’s data-dependence will likely cause the picture to evolve over the coming months.

However, currently the market sees the higher end of that range as more likely. The most likely outcome is now one additional hike from the Fed in 2022 as compared to early February. As such we’re looking at a most likely outcome of six or seven 25bps moves, compared to perhaps five or six a month ago.

As always, it is difficult to untangle market events. It is likely that concerns about rates are pushing markets lower, just as much as events in Ukraine. Plus, these events are related because the invasion has pushed up commodity prices, feeding into inflation that the then Fed looks to fight with higher rates, among many other impacts and second-order effects.

Still, it’s clear that recent events have not altered the markets take on 2022 being an aggressive year for rate hikes. In fact, slightly larger increases are now anticipated with the Fed perhaps moving up rates at each scheduled meeting this year. We should learn more from the Fed when they announce next Wednesday, March 16.