- Dec. 21, 2021
-- All eyes were on the Fed last week as the market awaited the latest policy decision and outlook – a decision that drew particular attention given the inflation environment. To its credit, the Fed brought no major surprises. As expected, it announced it will wind down bond purchases at a faster rate, acknowledging the elevated consumer price pressures that have persisted through the back half of the year. It did, however, convey a slightly more hawkish tone, which included an outlook for potentially three rate hikes next year. In a market that has become accustomed to – if not dependent upon – extraordinarily easy monetary-policy settings, it was the initial positive reaction in stocks to this tone that was perhaps the surprise in the week.
We think the accelerated bond taper is baked into the cake at this stage, with the timing of the first rate hike set to become investors' new fixation that will serve as a primary determinant of the equity market's flight plan ahead. As we taxi toward the runway, here are a couple takeaways on the Fed's 2022 liftoff:1. Faster recovery warrants an earlier departure.
2. Taper taxi will bring turbulence.
- There have been plenty of unique elements to the economic path over the last two years, including a return to pre-pandemic output (GDP) in record time. This has created unique conditions on the path toward monetary-policy normalization as well, including
- This will likely be the shortest time between the end of the preceding recession and the first hike. Since 1985, the average time was more than four years. A rate hike next summer would be roughly half of that.
- Inflation is the hottest it's been in three decades.
- The 10-year Treasury rate is below 1.5%, the lowest it's been approaching Fed tightening. Since 1985, 10-year rates averaged 5.3% at the time of the first Fed hike.1
- Liquidity is the most abundant, with Fed balance-sheet assets as a percent of GDP at the highest level since World War II.
Source: 1. Bloomberg
- The taper is the first step in this next phase of monetary policy, with the Fed likely to conclude bond purchases in the first quarter of 2022. We don't think this will deprive the bull market of oxygen, but we do believe this will usher in a new environment of market volatility, as this excess liquidity will no longer serve as the safety net to fully cushion market pullbacks, as was the case over the last year, which contained no 10% corrections and only one 5% decline that saw the S&P 500 return to new highs in just 14 days.