Given The Wide Set Of Rate Scenarios, Here’s What The Fed Is Watching In 2022

After today’s 25bps rate increase, Fed Chair Jerome Powell’s press conference statements made clear what he, and the rest of the monetary policy committee, will be watching for as 2022 evolves given the broad range of paths for raising rates seen by both the bond markets and the Fed themselves.

It really boils down to two things. First, the nature of inflation as transitory or more entrenched and secondly the strength of the job market, which is robust currently. In essence, the state of inflation, with inflation at a 40 year high for February is prompting the Fed to raise rates, and the strong jobs market is giving it relatively limited concerns about doing so currently.

Of course financial markets, Ukraine, supply chains, the broader international economy and other concerns will play into the monetary discussion too – yet the job market and inflation are likely to be the primary factors and the data the Fed watches most closely.

The Jobs Market

Powell made very clear he views the job market as “extremely tight” with people having a “hard time” hiring currently leading, in part, to his assessment that the risk of U.S. recession is low currently.

He emphasized that wage growth, the fact that there are 1.7 job opening for every unemployed person and other factors all pointing to just how strong the U.S. job market is today. Of course, Powell would never say that the U.S. job market is too strong, but as he talked about economic growth being ahead of trend and just how strong the job market was, Powell implicitly made it clear that he felt the Fed’s priority was more skewed to managing inflation currently. Indeed, he might appreciate a slightly less hot jobs market to the extent wage growth is feeding into inflation.

Inflation

On the other side of the Fed’s mandate, the transitory inflation debate has been ongoing for many months now. Aside from noting that inflation carries “upside” risks, today Powell discussed that in terms of worrying about “entrenched” inflation.

If inflation looks like it is hear to stay then the Fed is expected to take more aggressive action on rates. At one level. It’s a fairly simple question, the Fed hopes than inflation might start to decline by the middle of 2022 if a happens then that’s a fairly good sign that we’re looking at transitory inflation. Here the Fed hopes that base rate effects will play into that too. So as we start to lap some of the more aggressive price increases in the coming months from April to July of 2021 maybe inflation will start to be tamed.

How broadly inflation is spread across the goods and services is something the Fed will also monitor. Ultimately if inflation starts to moderate, does not spread across a host of goods and services and does not impact longer-term inflations for price increases, then the Fed may be more measured in its approach to higher rates. Rates will likely still go up materially in 2022 in this scenario, but less aggressively.

Seven Meetings And Seven Rate Hikes?

At the moment the number of hikes the Fed may make and the number of meetings scheduled for 2022 is just about equal. If the Fed choses to up rates 50bps at a given meeting rather than 25bps that will suggest more aggressive tightening than in currently anticipated.

On the other side, if the Fed choses to skip an increase at a scheduled meeting, maybe rate increases for 2022 are then on a less aggressive path. It was notable that one of the committee members wanted to see a larger, 50bps move at today’s meeting, though all other decision-makers supported 25bps.

So if inflation comes down and the job market softens, then the Fed may tend toward fewer rate increases this year. That’s something that would likely please financial markets, especially tech stocks, which have been hammered over recent months. However, if inflation remains stubbornly high especially in combination with a sustained robust job market, then the Fed may be more inclined to raise rates more than currently expected.