Market Week: February 7, 2022

The week in review

  • Nonfarm employment +467,000 in January
  • Unemploylment rate at 4.0% in January
  • Labor force participation at 62.2%, +0.3% m/m

The week ahead

  • January CPI
  • Consumer sentiment

Thought of the week
Market expectations have been pulled significantly forward in recent weeks as investors gear up for a more active and hawkish Fed amidst the background of a strong U.S. economy, low unemployment and high inflation. Six months ago, the market was pricing in just one Fed rate hike for 2022. Fast forward to today and the market is now expecting 5 rate hikes this year. As illustrated in the chart below, in August 2021, investors were anticipating that interest rate liftoff would begin in late 2022 with some even leaning toward early 2023. Current expectations thus signify a marked shift with investors now bracing for liftoff in March 2022 and steady increases thereafter. This is a short time for markets to adjust to such a meaningful move in rate expectations and is one of the reasons why we have been seeing a return to much more normal levels of volatility in markets after experiencing relatively low volatility in 2021.

At the January Fed meeting, Chair Powell confirmed this hawkish shift, stating that interest rate liftoff is imminent. He further stressed that the trajectory of future rate hikes is going to be
highly dependent on incoming economic data (think: PCE, unemployment rate). The Fed’s decisions are particularly sensitive to 1) inflation and 2) the labor market. On the first, we are in a very hot inflationary environment (CPI +7.0% y/y and PCE +5.8% y/y in December) that is proving to be less transitory than many once surmised. Second, the labor market is proving to be quite remarkable, boasting an unexpectedly strong jobs report last Friday. Powell has acknowledged that this economy is quite different than that at the start of the last tightening cycle and thus, Fed policy should reflect that. Additionally, Powell has left the door open to every Fed meeting being “live” and potentially
hiking more than once a quarter. Should inflation continue to heat up more than the Fed forecasts, then investors should expect to be met with more frequent interest rate rises and consequently, yields will likely stay choppy as investors recalibrate this new Fed path.

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