Team Transitory Stands Down

It seems you can retire the word transitory from your vocabulary, or at least from the Fed playbook, as Fed Chair Powell declared yesterday in testimony to the Senate Banking Committee.  Powell and Treasury Secretary Janet Yellen were there as required by the CARES Act to update the committee on the progress made, but the bulk of the questioning centered on inflation, and the impact of the new Omicron virus variant.

Powell somewhat shocked investors by saying that it was time to retire the word “transitory” implying that price increases had moved past just temporary phenomena and had become something more insidious, and that implied adjusting Fed policy. He mentioned possibly accelerating the pace of tapering, something the market didn’t expect to hear so directly at this hearing. The money quote was this, “At this point the economy is very strong and inflationary pressures are high. It is therefore appropriate in my view to consider wrapping up the taper of our asset purchases perhaps a few months sooner, And I expect that we will discuss that.”   The 2yr-10yr Treasury curve flattened by 11bps on that news, the flattest since January of this year, as the market priced back in nearly three rate hikes in 2022 while the longer-end rallied on the unequivocal declaration of war against inflation.

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Market Back to Expecting Nearly Three Rate Hikes in 2022

Ok, so it looks like we’re going to see a faster tapering schedule following the December 15 FOMC meeting. We had some doubts after Fed Chair Powell’s somewhat ambiguous comments on Monday, but when he said yesterday to retire the word “transitory” it was a declaration that there was a new sheriff in town, and he is there to vanquish inflation. Powell’s comments yesterday before the Senate Banking Committee left little doubt that a faster pace of tapering will be coming in 2022, probably ending in the spring.


Source: Bloomberg


Those direct comments, combined with other similar comments from Fed members, makes it pretty clear the Fed is ready to accelerate the pace of tapering to conclude in the spring of 2022 and pivot to rate hikes at some point later in the year. Atlanta Fed President Rafael Bostic had mentioned on Monday that the economy had enough momentum to survive another wave of Covid and Powell essentially reiterated the same thing on Tuesday before the Senate Banking Committee.

Consider too the Fed pretty much ignored the delta variant for the first couple months, barely acknowledging its presence, and never altering their policy as a consequence of it. That turned out to be the right move as delta, while making innumerable headlines, never had much lasting impact on the economy. In fact, in yesterday’s testimony Powell said he didn’t expect to see a new variant resulting in something comparable to last year’s  impact on the economy. While each variant can take on its own character it does seem with these comments  the Fed feels emboldened to repeat the same playbook with the latest variant, at least until the facts argue otherwise.

What that means is a probable acceleration of the tapering timeline in January with a wrap-up by spring leading to possible rate hikes in the summer or fall of 2022. The market had repealed one of the three rate hikes they had projected in 2022 last Friday when fears of the new variant first appeared but that hike is already being put back in place after the comments from Powell yesterday.

Fed Turns to Inflation Fighting Just As Commodity Prices Decline

As the previous section highlighted, it seems the Fed will be turning to a full-on war against inflation at the upcoming December 15 FOMC meeting, but will it be a case of turning to fight at just the wrong time? As the graph below shows, the Bloomberg Commodity Index has declined 10% since the high water mark reached on October 25. The index is comprised of 23 commodities and the biggest impact on the decline over the past month has been in the energy complex.

Source: Bloomberg

For example, West Texas Intermediate Oil constitutes 9.11% of the index, the third largest weighting, has declined 21% over the last month, obviously contributing significantly to the overall decline in the index. The drop, however, is not due solely to oil. The largest weighted member, natural gas, has declined nearly 27% over the last month.

These declines don’t take place in a vacuum. They occur because there is a shifting in supply and demand and it implies a slowing in the global economic outlook. Part of the most recent decline is no doubt due to the Omicron variant, but these declines began prior to the variant making any headlines. Could it be the market is sensing a slowing in global activity? Combined with the Fed’s sudden pivot to inflation-fighting it could signal a mistimed attempt to vanquish inflation just when it’s beginning to correct on its own. Of course, more goes into inflation than just commodity pricing but it does present an interesting picture of declining input prices just when the Fed is beginning to join the inflation battle.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.62 0.96 1.20 1.50 2.02 2.48
0.50 0.61 0.93 1.14 1.38 1.88 2.37
1.00 0.60 0.90 1.11 1.34 1.79 2.24
2.00 0.89 1.05 1.26 1.67 NA
3.00 1.22 1.61 NA
4.00 1.56 NA
5.00 1.52 NA
10.00 NA

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Published: 11/30/21 Author: Thomas R. Fitzgerald