Goldman Sachs says rising inflation could push Fed into more than four rate hikes this year

Accelerating inflation could prompt the Federal Reserve to be more aggressive than economists expect in how to raise interest rates this year, according to analysis by Goldman Sachs.

With the market already expecting four percentage points quarter increases this year, Goldman economist David Mericle said the omicron spread is exacerbating the upside and could push the Fed into pace with rate hikes. faster.

“Our baseline forecast calls for four increases in March, June, September and December,” Mericle said in a Saturday note to clients. “But we see the danger [Federal Open Market Committee] will want to take some tightening action at each meeting until the inflation picture changes. “

The report came just a few days before the policymaking team two-day meeting starting Tuesday.

Markets expect no action on interest rates after the meeting but it is certain that the committee will form a rally coming in March. If that happens, it would be the central bank’s first benchmark rate hike since December 2018.

Raising interest rates would be a way to combat soaring inflation, which is running at the highest in 12 months speed for nearly 40 years.

Mericle said that economic complications from the spread of Covid have exacerbated the imbalance between explosive demand and limited supply. Second, wage growth is continuing to be strong, especially in lower-paying jobs, even though enhanced unemployment benefits have expired and the labor market should have loosened.

“We see the risk that the FOMC will want to take some tightening action at every meeting until that picture changes,” Mericle wrote. “This raises the possibility of a balance sheet increase or release earlier in May and more than fourfold increase this year.”

According to CME data, traders are pricing in a close to 95% chance of a rate hike at the March meeting, and a more than 85% chance of four moves in all of 2022.

However, the market is now starting to tilt towards a fifth rally this year, which would be the strongest Fed rally investors have ever seen going back to the turn of the century. and trying to deflate the dot-com bubble. The chances of a fifth rate hike are closer to 60%, according to the CME’s FedWatch gauge.

In addition to raising interest rates, the Fed also reduce its monthly bond-buying program, with March being the current date to end an effort that has more than doubled the central bank’s balance sheet to just $9 trillion. While some market participants have speculated that the Fed may close the program at its meeting next week, Goldman does not expect that to happen.

However, the Fed may provide more indication of when to start remove its bond holdings.

Goldman forecasts that process will begin in July and be done in the amount of $100 billion monthly. The process is expected to take two or two and a half years and shrink the balance sheet from $6.1 trillion to $6.6 trillion. Mericle said the Fed will likely allow some of the proceeds from maturing bonds to roll out each month instead of selling the securities outright.

However, the unexpectedly strong and sustainable increase in inflation posed the opposite risk to the forecasts.

“We increasingly see a good chance that the FOMC will want to deliver some tightening action at its meeting in May, when the inflation panel is likely to remain fairly hot,” Mericle wrote. “If so, that could ultimately lead to more than four rate hikes this year.”

There are some important economic data to come out this week, although they will be released after the Fed meets.

Fourth-quarter GDP is due on Thursday, with economists expecting growth of around 5.8%, while the personal spending price index, the Fed’s preferred inflation gauge, is due out. on Friday and forecasts show a monthly increase of 0.5% and a year-over-year increase of 4.8%.