MNI:Fed Dots To Signal Two Rate Hikes in 2022, Openness To 3rd

The Federal Reserve’s dot plot next week is likely to show policymakers forecasting at least two interest rate increases for 2022 with some even seeing three if inflation pressures fail to abate, former Fed economists and policymakers told MNI.

“The December 2021 dot-plot will pencil in two rate hikes in 2022, with the potential for a third if the FOMC anticipates that meaningful inflationary pressures are likely to persist across the year stubbornly,” Rick Roberts, a former New York Fed staffer now at Monmouth University, told MNI.

That will mark a rapid shift from the Fed’s most recent rate estimates in September, which saw policymakers divided between whether to start hiking interest rates in 2022 or 2023.

"They've already begun tapering and even indicated speeding up the tapering. So, they've moved their expected path for policy a lot [but] they probably have a bit more adjusting to do given the inflation risks that we're seeing," said William English, former director of the division of monetary affairs at the Fed Board and secretary to the FOMC. As MNI has reported, the Fed is set to speed up its taper to potentially double the current pace so that March can be a “live” meeting for rate hikes. (See MNI: March Fed Meeting Seen Live For Liftoff, Ex-Officials Say)

U.S. inflation has far surpassed Fed and market expectations, with the consumer price index expected to have surged 6.8% in the year to November in a report due Friday, the highest reading in over three decades. This has forced a fairly rapid about-face by even once-dovish Fed policymakers.

HARD TO MANAGE

One reason for a hawkish tilt to the dot plot is that only two rate hikes would imply a break from past Fed practice of quarter-point tightening steps at every meeting, and that would be tough to explain to markets and the public.

“A median of two hikes next year is a reasonable prediction,” said Dennis Lockhart, former Atlanta Fed president, in an interview. “That said, it's challenging to carry off a cycle of rate increases that don't involve policy action at every meeting post-lift-off. An action followed by a pause followed by another action and so on requires careful communication. It's a more difficult process to manage.”

Claudia Sahm, a former Fed board economist, also expects a “notable shift toward two hikes, with balance sheet tightening done by March.” The desire by some Fed officials to simply jawbone inflation expectations lower might not be enough, she added.

“Forward guidance communication is clearly the strongest tool the Fed has and it’s not that strong right now,” Sahm said, pointing to a decline in market rates after Fedspeak turned more hawkish recently.

“If rates do not go up, the Fed is not slowing demand. They have to get the real economy to change its behavior, and that takes time. It will take even longer if interest rates that consumers and businesses pay don’t increase.”

THE POLITICS OF INFLATION

She expects Fed staffers to hold onto the notion that inflation is still largely temporary even though Chair Jay Powell has officially retired the term transitory and the FOMC is set to replace it at the upcoming meeting.

“My guess is staff is still holding onto inflation being transitory with the middle of next year as back under 2.5%,” she said. Crucially, however, “the FOMC will not agree.”

The surge in inflation to worrisome levels has suddenly made it a top political priority, likely making Powell’s press conference after next week’s meeting a difficult one for the newly-reappointed chair.

“I think Powell really is trying to signal that he is just as effective as Mr. Volcker,” in fighting inflation, said Joseph Haslag, a former Dallas Fed economist now at the University of Missouri. “I believe next week will be more anti-inflation rhetoric.”