Less than a month after Goldman capitulated and finally admitted it was dead wrong about its “transitory” inflation thesis – a laughably fragile argument, as just one look at the bank’s linearly rising monthly inflation forecasts would immediately reveal…
… and the bank pulled forward its first rate hike forecast from by one year mid 2023 to July 2022, this morning Goldman has fully thrown in the towel on any pretense that inflation will drop in the next few months (or year).
As a result, after noting that not only the latest FOMC Minutes released yesterday hinted at faster than expected inflation if not outright stagflation, but that Several FOMC participants have signaled over the last couple of weeks that they are open to accelerating the pace of tapering – including Vice Chair Clarida and most recently San Francisco Fed President Daly …
… the bank concludes that “the increased openness to accelerating the taper pace likely reflects both somewhat higher-than-expected inflation over the last two months and greater comfort among Fed officials that a faster pace would not shock financial markets” – something Goldman’s highly paid economists clearly were unable to express until just weeks ago.
The increased openness to accelerating the taper pace likely reflects both somewhat higher-than-expected inflation over the last two months and greater comfort among Fed officials that a faster pace would not shock financial markets. Some Fed officials might be persuaded to accelerate the taper by the upside inflation surprises over the last two months, especially on the shelter component. Other Fed officials, especially in the leadership, might have already expected inflation prints to remain high through the winter, but—with market pricing of rate hikes in the first half of 2022 rising—might now feel more confident that accelerating the pace, which is already more than twice as fast as the pace last cycle, will not produce the sort of unexpected market turmoil that reductions in balance sheet accommodation have sometimes caused in the past.
So with the Fed now also conceding that a faster taper is in the works, Goldman which was dismally wrong in its Fed forecasts until last month, now expects the Fed to announce at its December meeting that it is doubling the pace of tapering to $30bn per month starting in January.
In that scenario, “the FOMC would announce the final two tapers at its January meeting and implement the final taper in mid-March, several days before the March FOMC meeting”
And since the taper will now end in March, it also means that more hikes are coming: according to Goldman, while this faster pace of tapering would allow the FOMC to consider a rate hike as early as March, the bank’s best guess is that it will wait until June. By that point, a few additional employment reports will be available and will – perhaps – show a labor market that Fed officials feel more comfortable characterizing as having reached maximum employment. According to Goldman “The FOMC might say at its March meeting that it is evaluating the impact of tapering and will begin the discussion of rate hikes soon, then hint at its May meeting that a hike is coming soon, before ultimately hiking in June.”
In other words, Goldman now expects hikes in June, September, and December, for a total of three in 2022 (vs. two in July and November previously), followed by two hikes per year starting in 2023 (this is completely laughable as the market will crash long before then but let’s pretend Goldman knows what it is talking about for once).
It gets even funnier, because according to Goldman’s chief economist Jan Jatzius, there is also an alternative path of hikes at the May, July, and November meetings as a realistic possibility too.
Such an aggressive hawkish view from Goldman – which has been highly bullish on the state of the US economy in 2022 – is understandable, if odd especially when one considers that Morgan Stanley, which has a far more bearish outlook on the US economy in 2022 sees no rate hikes next year whatsoever.
In other words, 2022 is shaping up as a giant clash between the two most notable economist teams on Wall Street – Goldman, which sees three rate hikes, and Morgan Stanley, which sees zero. That’s also why as Hatzius concedes, the “largest risk to our expectation of an early liftoff is that some participants might find it hard to square a still-large employment gap relative to the pre-pandemic level with the guidance that the FOMC will not hike until the labor market reaches maximum employment… But we expect the unemployment rate to have fallen to 3.7% by June 2022, and we think that most participants, even many of the doves, will conclude that after a prolonged period in which job opportunities have been plentiful, any decline in the participation rate that remains by the middle of next year is likely to be mostly voluntary or structural.”
Actually there is an even larger risk: a recession next year as the economy collapses under its own weight since no more stimmies are propping up the US consumer. The largest risk, however, is a “catastrophic” 10%+ drop in the market which would put an immediate end to any tightening plans the Fed may have and lead to QE and potentially NIRP over the next 12 months. We will be sure to follow up on this post in 12 months to see who was right.