Goldman Now Expects 4 Rate Hikes In 2022… And Why This Has No Chance Of Happening
As stocks plunge, yields and the dollar soar and the economy slows with every passing day as instead of spending their long-gone stimmies, US consumer go on a record credit-card fueled spending spree…
… the ivory tower experts on Wall Street are now trying to one-up each other on who can come up with the most ridiculous number of Fed rate hikes and balance sheet runoffs.
Case in point, over the weekend, both Goldman and Deutsche Bank decided to show how cool, hip and edgy their Fed watching teams are, when both increased their forecast for number of rate hike. Goldman now expects to see in 2022 to 4 from 3 and also now forecast the Fed to begin shrinking its balance sheet in July: According to Goldman t”he already ultra-low unemployment rate has made Fed ofﬁcials more sensitive to upside inﬂation risks and less sensitive to downside growth risks” which is a big mistake because in a hyperfinancialized economy such as this one, consumer spending will collapse as soon as stocks tumble, even ignoring the lack of further stimmies onthe horizon.
Still, at least Goldman confirms what we said just minutes after the Omicron news broke last November, when we predicted that this variant would be much more mild and have far lesser consequences for the world. This is what Goldman’s Jan Hatzius says: “both confirmed cases and hospital admissions are now on a downward trend not only in South Africa but also in London, the first place in the Northern Hemisphere to see a major outbreak. If this pattern holds up elsewhere, the economic impact should be largely behind us by the end of Q1, at least in the advanced economies.”
Which of course is true, but the far bigger weakness in 2022 will come from that dynamo of US GDP – personal consumption – which slumps in the coming months as even Goldman economists realize that all those “pent up savings” which had been accumulated in the first half of 2021, have been spent by the middle class.
In any case, putting it all together, Goldman writes that “even with four hikes, our path for the funds rate is only modestly above market pricing for 2022, but the gap grows significantly in subsequent years. Our rates strategists recently discussed two potential explanations for why longer-dated funds rate pricing is so low: a) an extremely low market estimate of nominal r* and b) a supply-demand imbalance resembling the pre-2008 bond market conundrum (see Goldman Spots A “New Bond Market Conundrum“).”
Goldman thinks that “both play a role, but neither is likely to keep the funds rate from ultimately rising well above the 1.6% now discounted in market pricing.” And here is where the most influential bank makes another huge mistake, claiming that “nominal r* is probably higher than in the last cycle, in part because of larger long-run fiscal deficits and in part because of the Fed’s higher effective inflation target.”
We disagree for the simple reason that there is now just far too much debt in the world, and pushing rates to catch up to r star, whatever it may be, will lead to a bond market shock which the Fed will never allow and is why Powell is now completely trapped between chasing runaway inflation while being terrified his actions will crash risk assets, despite whatever assurances he may have given to Biden as part of his reelection campaign.
Wrong or not, Goldman’s latest hawkish pivot was echoed by Deutsche Bank’s chief economist Matthew Luzzetti who wrote that the German bank now also expects that “liftoff will occur in March and that the Fed will undertake four total rate hikes this year. As the minutes signaled, the Fed will be very nimble in responding to the incoming data, making consecutive rate hikes or even larger increments possible. Beyond 2022, we maintain our view of three rate increases in 2023 and the terminal rate (2.1%) for fed funds.”
In addition to rate hikes, DB now expects quantitative tightening to commence in Q3:
Our baseline is that the Committee releases details on the runoff caps around the May FOMC meeting with the announcement of rundown coming shortly thereafter (our baseline is July). Our preliminary calculations suggest that while runoff would be $300-400bn in the second half of this year (depending on how they structure the caps), it would be around $1tn in 2023, representing a significant tightening of financial conditions that would equate to roughly two hikes in total.
And while both Goldman and Deutsche Bank may be absolutely correct in estimating that to catch up to inflation the Fed will have to hike substantially in coming months, the reality is that the market is now far more “late cycle” and thus much more sensitive to even the smallest tightening in financial conditions as Matt King pointed out in his latest must read presentation (available to pro subs in the usual place) which noted that for the economy alone “neutral rates may well be much higher now“…
… but – and this is absolutely critical – “neutral rates for markets likely well below neutral for the economy”…
… as “markets are much closer to late-cycle than the economy”.
Putting all of this together what are the implications? Well, the Fed may indeed hike once or twice in early/mid 2022 but once markets realize that Powell is indeed serious with correcting its “transitory inflation” mistake which dominated the Fed’s thinking for much of 2021, risk assets will simply crater.
From there, as One River CIO Eric Peters wrote in his latest note over the weekend, “for all the portfolio reshuffling and stop-loss selling, not a single market participant doubted that the Fed stands ready to bail everyone out in a market crash. Such conviction is well-supported by decades of repeated behavior from our accommodating central bank.”
Indeed, as we noted today, we have now entered the phase where, with the Fed still actually growing its balance sheet and rates still at zero, traders are hunting the level where the Fed’s revised put is triggered…
Market is smart: the faster we crash, the faster the Fed’s Blackrock subsidiary buys ETFs. pic.twitter.com/TA9WA2JPYu
— zerohedge (@zerohedge) January 10, 2022
… and Powell has no choice but to back down, even if inflation remains red hot, leaving the Biden admin with just one option: revise the definition of inflation to make it seem much more palatable, something we already know is on the way…
… because continuing the current approach assures of a catastrophic outcome in this year’s midterms, where democrats would be facing not just surging prices but a stock market crash. And not even Joe Biden is confused enough not to realize that this spells doom for both his party and his re-election chances.
As usual, all reports mentioned in this note are available to pro subscribers.
Mon, 01/10/2022 – 11:12