The forecast changes are coming in fast and furious.
We kicked off the week with Goldman upping its view of Fed rate hikes to now include half-point hikes at the next two meetings. Then we got Fed Chair Powell basically confirming that possibility in his speech on Monday. Yesterday, Morgan Stanley joined the two-half-point-hikes camp.
This morning, Bank of America--the first to call for seven quarter-point hikes this year--also joined that call, except it thinks the half-point hikes will occur a meeting later (in June and July). Then, Citi's new forecast hit the street; they're now expecting four half-point rate hikes this year, and think the Fed will ultimately take the funds rate (currently just below 0.5%) all the way up to 3.5% to 3.75%.
In response to these breathless developments, interest rates keep moving higher. The 10-year Treasury yield rose above 2.5% this morning--up from 1.5% at the end of December! And perhaps most remarkably, the Dow and S&P 500 are rallying again this morning as I write this.
So, what gives? Why are economists (and Fed policymakers) stumbling over each other to raise their rate hike expectations all of a sudden? Three things, I'd argue:
(1) Inflation expectations keep rising. The market has completely shrugged off the Fed's recent "hawkishness" and keeps expecting higher and higher medium-term inflation--nearly 3.6%, on average, over the next five years now, versus less than 2% expected inflation at the end of December. Fuel and food prices are not really the story here, either--it's the super strong labor market, with expected 5% wage inflation for the next year or so. The Fed, in other words, may be falling further and further behind the curve even as they are scrambling to tighten.
(2) Stocks keep rallying. The S&P is now down less than 5% this year. And we're up 8% from the close on March 14 (eleven days ago!), right before the Fed's meeting where they dramatically upped their rate hike projections and Powell deepened his hawkish warnings. That means all the hawkish street forecasts outlined above have also done nothing to dent stocks' recent strength. This is the polar opposite of the market's reaction last cycle, when it would freak out about hikes and sell off until the Fed backed down.
(3) The labor market is still booming. New jobless claims have all but disappeared, falling to a fresh fifty-year low last week. The job openings data were revised to a fresh all-time high that barely moderated as of the January report (showing 11.3 million openings), contributing to the biggest jobs-to-workers gap in postwar history, according to Goldman. That all points to the wage inflation mentioned above, which will keep upward pressure on service prices (think healthcare, for instance) independent of whatever happens with food, fuel, and goods prices later this year.
And on top of all that, the yield curve (based off of three-month bills, as the Fed prefers) has been steepening. That's a sign the market expects growth to accelerate in the months ahead. In other words, the market is giving the "go" signal on tightening to the Fed, even as it gets more and more hawkish. Economists see it; the Fed itself sees it; investors are seeing it, too. And it ain't over, yet.
See you at 1 p.m!
Kelly
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