The Market and FOMC Ring In the New Year in Harmony

January 6, 2022

Source: Bloomberg Source: Bloomberg

Happy New Year from the team here at PMAM. We hope everyone had a happy and safe holiday season. For many of us who got to spend time with family, dinner conversations more than likely turned toward the topic of inflation. From the cost to prepare your favorite holiday meal, to the price and effort taken to buy a popular toy, rising costs were certainly felt this year.

Entering 2022, inflation will remain a hot topic for investors. Wage increases and fiscal stimulus have hopefully allowed households to adjust to the increased costs of goods and services. For the economy, the hope is that growth remains strong until price pressures show signs of abating. A key risk facing the economy in 2022 will be how growth and inflation progress as the Federal Reserve embarks on its next cycle of monetary policy tightening. 

Today’s Chart of the Week shows a snapshot following the December Federal Open Market Committee (FOMC) meetings in 2016, 2018 and 2021. Using Bloomberg’s World Interest Rate Probability (WIRP) and FOMC Dot Plot (DOTS) functions, we can look back at the FOMC’s projection for monetary policy relative to market expectation. 

In 2016, the FOMC median forecast was for three 25-basis-point rate hikes in 2017, while the market was pricing in two to three. If you can recall, 2017 was the year of the “Goldilocks” economy: growth and inflation that were neither too hot nor too cold. As a result, the market began pricing in a rate hike for the March 2017 FOMC meeting. The FOMC did raise rates in that meeting, as well as two other times in 2017. Risk assets performed strongly that year with very low volatility.

After the December 2018 FOMC meeting, the market was not aligned with FOMC projections. Growth and inflation had started to slow, which warranted a slowdown or pause to the current hiking cycle, yet Chairman Powell and the FOMC were forecasting more rate hikes for 2019. The selloff in risk assets that began after Powell’s infamous "long way from neutral" comments in early October continued until he and the FOMC pivoted away from further rate hikes in January 2019. With the FOMC back in alignment with what the market and economy were saying in regard to monetary policy, risk assets had a strong year in 2019.

Key Takeaway

After the December 2021 FOMC meeting, the market and FOMC appear closely aligned in their forecasts for monetary policy entering 2022. As we saw in 2016 and 2019, this may be the key ingredient to keeping risk assets happy during a tightening cycle. 

In my view, however, 2022 will be more challenging for the market and FOMC to navigate. Growth and inflation are in much higher and wider ranges than we experienced over the previous hiking cycle. The ongoing pandemic has brought new dynamics to the equation. Pent-up consumer savings, economic disruptions from COVID-19-related shutdowns, extraordinary fiscal policy and a changing labor force will critically impact growth and inflation in 2022, posing challenges to keeping the market and FOMC expectations aligned.

Tags: Inflation | FOMC | Market volatility | Interest Rates | Monetary policy | COVID-19 pandemic

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