Adapting to a hawkish Fed

Just about a year ago, the market expected the Federal Reserve (Fed) to keep the target rate at zero through 2022 with rate hikes expected only from 2023. However, more recently, the Fed has pivoted and indicated in recent meetings a desire to normalise the federal funds rate to neutral.

The U-turn in the Fed’s monetary posture is catalysed by the four-decade high level of inflation, which hit 8.5 per cent in March 2022. The transitory-inflation thesis that the Fed previously leaned on, posits that price pressures were mainly caused by the pandemic and were therefore, temporary. However, recent data has suggested that inflationary pressures were broad-based and more persistent than expected. 

Furthermore, the devastation of Ukraine’s economic output and the economic sanctions on Russia have led to a massive disruption in the commodity markets. For instance, prices of oil and commodities such as nickel have surged. While higher energy and commodity prices caused by a geopolitical event will impact headline inflation readings in the near term, the second-order impact to core inflation readings is likely to be limited. Moreover, monetary policy acts on demand rather than supply.