The Biggest Tail Risk

No Hike, Small Dot Plot Move

The Fed didn’t hike rates in March shocking no one. It’s a huge mistake to think the Fed will hike rates this year or next year. Anyone making that mistake isn’t listening to the Fed call the coming bout of inflation temporary. It’s a little bit easier to call inflation temporary now with CPI so low. It will get harder this summer when CPI rises, but the Fed will stick to its plan.

The dot plots changed marginally. As you can see below, 4 FOMC members see a hike in 2022 which was up from 1 in December. Now 7 see a hike in 2023 which was up from 5 in December.

There has been a lot of positive vaccine news, the breakeven inflation rate has spiked, and two stimulus plans passed since the last dot plot in December. The fact that all this big news only caused 2 more Fed members to see a hike in 2023 is extremely dovish. The Fed has a new framework. It is letting the economy run hot. Investors should get used to this.

As we mentioned, a lot changed since December. This caused the Fed to increase its 2021 GDP growth forecast from 4.2% to 6.5%. Even with that change, it doesn’t see hikes through 2023. We mentioned that there might be a moment where the Fed and the market clash this summer. That may have come early because much of the growth upgrade has been made, yet the Fed stayed dovish. It’s unlikely that the Fed substantially raises its 2021 GDP growth forecast.

The Fed thinks the unemployment rate will fall to 3.9% in 2022 which is below its longer run rate projection. Normally, that would imply hikes, but not with the new framework. The Fed raised its 2021 core PCE inflation rate projection 4 tenths to 2.2%. It would be remarkable for inflation to stay that low. If that projection is hit, the Fed is many years away from hiking. 2.2% isn’t close to enough to make up for the weak inflation in 2020. Core PCE inflation was 1.4% in 2020. If the Fed is forced to raise its 2021 core PCE inflation projection a few tenths higher, it might get more hawkish.

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