By Kevin Flanagan, Head of Fixed Income Strategy
The final FOMC meeting for 2021 is now in the books and the money and bond markets are poised to turn the calendar. If you think about where monetary policy expectations were to begin this year, or even just three to six months ago for that matter, it has been a notable transformation.
If you had broached the idea that the Fed would be raising rates in 2022, let alone multiple times, your argument would have been dismissed out of hand. But now, it’s beginning to look a lot like rate hikes may be coming next year.
First, though, the Fed needs to finish up some balance sheet business—tapering. The December FOMC meeting laid the groundwork for the Fed to end their tapering process sooner than originally outlined.
Fed Balance Sheet
Once this part of their exit strategy ends, the policy makers will need to decide on what to do with their holdings of Treasury and mortgage-backed securities when they mature. In my opinion, the first step will be to roll over the proceeds of the maturing debt on the Fed’s balance sheet and revisit this issue later on.
That brings us to the ultimate headline-maker, liftoff. Until now, Chairman Powell had basically given the thought of rate hikes the proverbial Heisman. To quote him from the November FOMC presser, the “rates-liftoff question isn’t before us now.”
My, how things have changed in six weeks’ time. Indeed, the blue dots (the Fed’s projections for Fed Funds) have now shifted to 2022 for the median estimate. Remember when the first rate hike wasn’t expected until after 2023?
The question before the markets now seems to be when is actual liftoff, and how many rate hikes to expect? In my opinion, Chairman Powell needs to provide that forward guidance in order to avoid any surprises and/or misinterpretations.
As of this writing, the implied probability for fed funds futures is looking at Q2 (May/June) as the start date and around two to three rate hikes for 2022 as a whole.
Lately, there has also been some concern about a potential policy mistake or the Fed becoming too hawkish. Utilizing Powell’s prior bout of rate hiking as a guide, I feel the Fed will be deliberate in their rate-hiking approach, at least to begin with.
Then, if inflation continues to run ‘too hot’ (as is the present case), the policy makers may take a more aggressive turn.
Conclusion
Where does that leave us? Quite simply, rising rates is our primary theme for 2022. In our most recent Office Hours, on the inflation front, we asked advisors if rate hedging had become a priority for the bond portion of their portfolios. A little more than 40% answered: Not yet, but they are actively considering it.
Advisors may want to start implementing such solutions now, because as we’ve seen this year, Fed policy could look much different in the months ahead than what is currently expected.
This post first appeared on December 15 on the WisdomTree blog.
Photo Credit: Kevin Dooley via Flickr Creative Commons
DISCLOSURE
There are risks involved with investing, including possible loss of principal. Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, currency, fixed income and alternative investments include additional risks. Please see prospectus for discussion of risks.
Past performance is not indicative of future results. This material contains the opinions of the author, which are subject to change, and should not to be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Neither WisdomTree nor its affiliates, nor Foreside Fund Services, LLC, or its affiliates provide tax or legal advice. Investors seeking tax or legal advice should consult their tax or legal advisor. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
