At the start of the month, not long after Goldman capitulated and brought forward its first Fed rate hike forecast by one year to July 2022, virtually every Wall Street bank promptly followed in Goldman's footsteps turning uber hawkish and expecting several rate hikes and/or accelerating tapering over the coming year. All, expect Morgan Stanley, which stubbornly refused to yield to peer pressure and continued to forecast no rate hikes in 2022 whatsoever.
This remarkable divergence in Fed outlooks between the two most influential banks promoted us to tweet on Dec 1 that "2022 shaping up as a huge showdown between Goldman and Morgan Stanley. Former says 2, maybe 3 hikes; latter say no hikes. One will be spectacularly wrong."
2022 shaping up as a huge showdown between Goldman and Morgan Stanley— zerohedge (@zerohedge) December 1, 2021
Former says 2, maybe 3 hikes; latter say no hikes.
One will be spectacularly wrong
Just a few days later, with inflation soaring to a fresh 39-year-high (although perhaps finally topping out), Morgan Stanley decided to gracefully and quietly tap out and this week the bank's -chief US economist Ellen Zentner, pulled forward the bank's rate hike path by 6 months to September 2022, acknowledging that it was wrong and admitting that there has been a "pivot in the Fed's reaction function."
Even so, Morgan Stanley still remains well beyond market expectations, saying it has "even greater conviction" in its call that core inflation moves off its highs in 1Q 2022, which however further validates concerns that the Fed is engaging in a policy error and tightening into a recession.
Here are some more details from Zentner's note:
Before investors close out the year, we need to get past the FOMC's final meeting next week, and it comes with every opportunity for surprise. On Wednesday, we expect the Fed to move to a hawkish stance by announcing that it is doubling the pace of taper, highlighting continued inflation risks and no longer labeling high inflation as transitory, and showing a hawkish shift in the dot plot. We think this shift will shake out in a 2-hike median in 2022, followed by 3.5 hikes in 2023 and 3 hikes in 2024.
At the end of the meeting, we think the FOMC's median view will align more closely with ours – we look for 2 hikes in 2022, followed by 3 hikes plus a halt in reinvestments in 2023. Moreover, we expect the Fed's median forecast for core PCE and the unemployment rate will also come in reasonably close to our own, which now has higher inflation receding to around 2.5% 4Q/4Q next year, and the unemployment rate back to its pre-pandemic low around 3.5% in 4Q22. The incoming data on the labor market and inflation has strayed materially from the Fed's outlook and therefore warrants what we deem to be a sea change in its stance on the appropriate path for policy.
At the same time, Zentener also says that the timing of liftoff in the bank's forecast is tied closely to inflation outcomes, with its base case expectation that following the current re-acceleration in inflation we have been expecting, core PCE shows some slowing beginning in February next year. The pace of this deceleration will be important in determining how much of a breather the Fed takes between the end of its asset purchases and the first rate hike.
Separately, on Friday we received data on inflation for the month of November showing that on a year-over-year basis, core CPI increased to 4.9% from 4.6%. Headline CPI ran at the highest rate since 1982. Despite the alarming headlines, financial markets seemed to be relieved at the results. Why? Because, according to Morgan Stanley, for the first time in months the month-over-month increase of 0.5% was in line with expectations instead of delivering an upside surprise.
Going back to Morgan Stanley's mea culpa, Zentener writes that in her outlook, the biggest out-of-consensus call has been the view that core inflation will show signs of slowing in 1Q22 as pandemic-related price pressures, particularly in goods, are slowly abating. She says that today she has "even more conviction in that view" and here's why:
We are seeing nascent signs that pipeline inflation pressures are easing – based on evidence from company earnings transcripts, ISM comments, Korea trade data, China's inflation data, the Fed's Beige Book, a department huddle with our equity analysts, and our own survey.
While Zentener admits that these sources by no means suggest that normalization "is well under way," but at the very least they indicate that "bottlenecks have peaked" and the chief economist expects that in a few months, "this trend will work its way through the pipeline to finished goods prices at the consumer level." It is unclear if Morgan Stanley's previous thesis of a huge - and deflationary - inventory glut as supply chains blockages ease,
In parting, the Morgan Stanley economist tries to deflect some of the blame for having been wrong in its call, and says that "to be right on our Fed call for 2 hikes in 2022, not only do we have to be right on the path for core PCE, but Chair Powell has to be willing to direct attention to slowing inflation as a way of pushing back on market expectations that are now pricing in nearly 3 hikes, with a healthy probability the Fed could begin as early as March."
But while Morgan Stanley is at least somewhat cautious about going hawkish, Goldman no longer has any such qualms, and moments ago on Saturday afternoon, the bank went all in on its hawkish relent... and so one month after pulling forward its call for a rate hike by over a year to July 2022, the bank now says that "the FOMC is very likely to double the pace of tapering to $30bn per month at its December meeting next week, putting it on track to announce the last two tapers at the January FOMC meeting and to implement the last taper in March." As a result, Goldman now expects the FOMC to deliver rate hikes next year in May, July, and November (vs. June, September, and December previously) and another 4 in 2023 and 2024 (spread evenly 2 and 2). Some more details from the full note, which as usual is available to professional subs.
New information about both inflation and the labor market since the FOMC last met supports a faster taper pace and an early liftoff. Inflation has increased further as prices of durable goods and shelter have continued to rise rapidly, though wage growth has slowed since enhanced unemployment benefits expired in September. Labor market slack has diminished rapidly, roughly in line with our expectations but faster than Fed officials expected.
Chair Powell has indicated that the FOMC is likely to retire the word “transitory” from its statement and instead explain that it thinks the current period of elevated inflation is unlikely to “leave a permanent mark” by raising long-term inflation expectations. More meaningful changes to the statement, especially to language about inflation having run persistently below 2%, are also possible.
We expect the Summary of Economic Projections to show somewhat higher inflation and lower unemployment. Our best guess is that the dots will show 2 hikes in 2022, 3 in 2023, and 4 in 2024, for a total of 9 (vs. 0.5 / 3 / 3 and a total of 6.5 in September). We think the leadership will prefer to show only 2 hikes in 2022 for now to avoid making a more dramatic change in one step, especially at a meeting when the FOMC is already doubling the taper pace. But if Powell is comfortable showing 3 hikes next year, then we would expect others to join him in a decisive shift in the dots in that direction.
In conclusion, Goldman's forecast calls for 3 hikes in 2022 (vs 2 for Morgan Stanley) and then 2 per year starting in 2023. The bank also expects two hikes per year starting in 2023 because like MS, it also expects inflation to fall to moderately above 2% and growth to slow to just above potential by then.
That said, Goldman's Jan Hatzius says that he "inferred from the September dots that Powell and Governor Brainard envision hiking twice per year in that environment, a slower pace than last cycle that we assume reflects the new monetary policy framework." However, the bank will watch the December dots to see if they still view that as the default pace.
Or, one can just look at what the market is saying and the conclusion there is clear: with the 4Y1Y - 2Y1Y curve inverting...
... as STIR traders now expect rates in 2023 to be higher than in 2025, the verdict is simple: not only is the Fed engaging in policy error, hiking into an economic slowdown - with inflation having already peaked, someone has yet to explain to us how monetary policy will help alleviate supply chains, for example - but it will then proceed to rapidly cut rates (perhaps to negative) while injecting trillions more in QE once markets crash (amid the coming rate hike panic detailed meticulously by BofA CIO Michael Hartnett) to reflect the Fed's panicked actions (which an objective observer could say reek suspiciously of political pandering to appease Joe Biden who is clearly freaking out about his collapsing rating and the impact inflation is having on it) some time in late 2022, just before the midterms.