A just-published report updated our view on the budding U.S. rate-hiking cycle. While a steady stream of rate increases is discounted this year, expectations for 2023-2024 show a unlikely, in our opinion, flattening and then mild easing in rates. The Fed and the bond market have undergone a huge pivot in recent months, after initially viewing the rebound in inflation as being transitory. However, both are still well behind the curve if our upbeat economic view pans out.
Importantly, U.S. inflation is far more entrenched that the majority expects, and much broader than just goods price inflation related to supply problems. U.S. service sector inflation is already contributed more to core CPI than goods inflation. Moreover, and more critical for the longer-term outlook, there are growing signs that the era of muted wage gains is over. The risk is that a self-reinforcing cycle of price increases and higher inflation expectations & wages becomes entrenched, to the point where it might necessitate a recession to bring them under control.
The report concluded: the FOMC will have to hike policy rates more than the Fed and the bond market currently expect, in 2023 and 2024.