Great Inflation Debate: When And How Big?

Jim Bianco at Bianco Research shares his views on inflation and when the Fed will hike.

When and Why Will the Fed Hike?

This is a guest post by Jim Bianco who explains his views on When Will the Fed Hike and Why.

Summary

The market is starting to see a Fed hike on the distant horizon. This is how a shift in thinking begins. The driving reason for this change seems to be a resurgence of inflation over booming real growth.

Over the summer the Fed started suggesting they would hold off on any rate hikes for years. In late July (brown line) the market was flirting with the idea of negative rates, as shown by the fed funds futures curve.

By late October (blue line) the forward curve was back to positive, but still not pricing in a rate hike for years. A rate hike is expected when the implied yield is above 0.125%.

The combination of the election and Pfizer’s vaccine news resulted in the fed funds curve jumping higher (cyan and red lines). This morning (orange line), the market is getting closer to pricing in a 2023 rate hike. 

This is how a shift in thinking begins. The market prices in a distant hike and then starts to move it closer and closer to the present as data warrants.

Why Is This Happening?

The surge in risk assets suggests the market is expecting booming real growth to be the catalyst for the shift toward a more hawkish Fed.  

The next chart shows the jobs lost from the pandemic (cyan) and the projection of non-farm payroll growth from a survey of about 70 economists conducted by Bloomberg (shaded area). To date, over 10 million jobs lost to the pandemic have yet to be recovered (green line). This shortfall is expected to be cut to 4.7 million jobs by the end of 2021 (cyan line). Given the Fed’s preference for jobs over inflation, this means there should be no talk of the Fed hiking rates. Yet the market is inching toward that reality.

Restoration of Jobs

Tracking the restoration of jobs

This same survey of economists expects economic growth to slow to pedestrian levels between now and the end of next year. No estimate, even after factoring in the election and vaccine news, expects real GDP growth to top 4% through the end of 2021. It is too early to consider 2022 forecasts.

With these levels of expected growth, real GDP is not expected to recover its previous peak (Q4 2019) until Q4 2021 (black line).

Measuring the Expected GDP Contraction

Measuring the Expected GDP Contraction

All of this is to say there is no reason for the market to start thinking about rate hikes, or even higher long rates. But that is what is happening. Why?

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