event:
According to the minutes of the interest rate meeting of the Federal Reserve on December 14-15, 2021, the participants changed their previous views on "temporary" inflation, reached an agreement on accelerating taper, and held in-depth discussions on interest rate increase and table contraction. After the release of the minutes of the interest rate meeting, the market sentiment was depressed: the yield of 10-year US bonds rose 3bp to 1.7%; The S & P 500 index fell 1.94%; The Dow Jones index fell 1.07%; The NASDAQ fell 3.34%.
Core view:
The minutes show that the Fed's monetary policy has significantly turned eagle, and there are in-depth discussions on accelerating taper, raising interest rates and shrinking the table, reflecting that the Fed may tighten monetary policy earlier or faster. At this stage, Omicron's impact on the economy is significantly weaker than expected (see our report "strengthening needles and specific drugs to prevent medical runs, and the world can be expected to open again" released on January 3, 2022), superimposed with the rapid repair of the U.S. labor market and the continuous demand for enterprise replenishment, supporting the steady recovery of the U.S. economy and driving up the real rate of return. The pressure of high inflation will also make the Fed's monetary policy likely to continue its hawkish style and support short-term interest rates. Overall, the constraints hindering the upward rise of US bond yields are fading.
Raising interest rates may speed up
According to the minutes of the meeting, based on the current expectations of the U.S. economy and inflation, FOMC participants believe that interest rates may be increased earlier or faster than opposed. The dot matrix of the December meeting shows that the median forecast of the federal funds rate in 2022 has risen significantly to 0.9% from 0.3% in September. It can be seen that the probability of monetary policy tightening by the Federal Reserve is rising. We will discuss it from two aspects: inflation and economy.
Inflation pressure continues to heat up, and the Federal Reserve may accelerate the tightening of monetary policy.
According to the minutes, most all participants stated that they had revised up their forecasts of inflation for 2022, due to the slow repair of the supply chain, the imbalance between labor supply and demand, and the continuous rise of housing prices. In the statement of the December interest rate meeting, the Federal Reserve also deleted the description of "transient" inflation. Powell said that the current US inflation may last longer, indicating that the Federal Reserve acknowledged the previous misjudgment on the level and duration of inflation and corrected it in time.
A big reason why the Fed attaches so much importance to inflation is that the real inflation will drive inflation expectations upward and interact with each other to make inflation further upward. The most important factor determining inflation expectations is the market's confidence in the Fed's anchoring inflation expectations. It can be seen that before the December meeting, Powell had always called inflation "temporary", which was interpreted by the market as the wrong judgment of the Federal Reserve on inflation. Inflation expectations (expressed by the 10-year breakeven inflation rate) continued to rise. Based on the most commonly used inflation data in the United States, we can find that the inflation pressure in the United States is already at a high level, A number of long-term inflation expectations in the United States also continued to rise. The Fed needs to respond positively to avoid the interaction between inflation and inflation expectations, which will continue to rise. Therefore, from the perspective of inflation expectations, we believe that the possibility of the Fed raising interest rates is rising.
The economy recovered steadily and raised the probability of raising interest rates
At the interest rate meeting in December, the Fed revised the median forecast of real GDP growth in 2022 to 4% (3.8% in September), mainly due to three factors. First, the overall labor market in the United States recovered rapidly. In November 2021, the unemployment rate dropped to 4.2%, close to the Fed's maximum employment target of 4%. Second, the overall inventory in the United States is still low, and enterprises are expected to continue to replenish the inventory to support economic growth. In December 2021, the overall inventory sales ratio of the United States was 1.24, with a gap of 0.18 compared with 1.42 before the epidemic, and the PMI new order index continued to be in a strong expansion range (ISM PMI new order index was 60.4% in December). It is expected that after the demand remains strong and the supply chain problems are alleviated, the demand of American enterprises will further support the economy. Third, although the resident savings rate and personal disposable income have fallen from the high point at the beginning of the epidemic, they are still at a more reasonable level, which is expected to support the growth of consumption.
Looking ahead, we believe that Omicron's constraints on the economy will be significantly weaker than expected. Although Omicron is highly infectious, the number of severe cases and deaths caused by Omicron has not increased significantly. Moreover, the vaccine protection was significantly enhanced after vaccination with enhancer. It is expected that the impact of Omicron on the economy will be weaker than expected, and the track of steady recovery of the U.S. economy will remain unchanged. Refer to our report "strengthening acupuncture and specific drugs to prevent medical run, and the world can be opened again" issued on January 3, 2022. Therefore, from the perspective of economic recovery, the possibility of the Federal Reserve starting to raise interest rates in advance is also rising.
Accelerating taper gives the Fed more policy options, which does not mean that the Fed will raise interest rates immediately.
According to the minutes of the meeting, the FOMC monetary policy meeting on December 14-15, 2021 announced as scheduled to accelerate the reduction of asset purchase (taper) from January 2022, reduce the purchase of US Treasury bonds of US $20 billion and institutional mortgage-backed securities (MBS) of US $10 billion per month, and end the whole process of taper in March 2022. Ending taper early means that the Fed has more space and room to adjust monetary policy when dealing with inflation risks. If inflation continues to rise in 2022, the Fed can act quickly (raising interest rates) without being constrained by the unfinished taper. On the other hand, if inflation begins to weaken in 2022 and the economy recovers from weakness, the Fed will delay raising interest rates.
After the interest rate hike begins, the table contraction may follow
According to the minutes of the meeting, most participants believe that the table reduction may be approved to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate. Moreover, compared with the previous table contraction, the interval between this table contraction and interest rate increase may be shortened. This also shows that on the agenda of the normalization of the Fed's monetary policy, both interest rate hikes and table contraction are under consideration.
There are two reasons why the Fed began to consider shrinking the table in advance. First, the U.S. economic outlook is stronger than before the tightening of previous policies, inflation is at an all-time high, and the labor market is also recovering steadily. All signs show that the U.S. economy is in a hot state, close to the requirements of the Federal Reserve to start shrinking. Second, at this stage, the money market reserve supply is very abundant, and the existing interest rate control means of the Federal Reserve (overnight reverse repurchase, on RRP) are superimposed, so that the disturbance of the table contraction on the federal fund interest rate is within the controllable range.
