Last week's consumer inflation reading reinforces the narrative that the Federal Reserve will quicken its pace to taper asset purchases, setting the stage for an earlier rate increase when the central banks' policymakers meet on Tuesday and Wednesday.
Investors will also gain insight on the central bankers' expectations for when rates will rise with the release of the "Summary of Economic Projections," especially the closely watched "dot-plot."
Expect to see a change in timing for winding down its purchases of Treasurys and mortgage-backed securities. At their November meeting, the Fed said it planned to reduce purchases by $15B per month, setting a pace to end the purchases in mid-2022.
Fed Chair Jerome Powell has already said it's time to talk about speeding up the taper by a few months. "At this point, the economy is very strong" and inflation is elevated, he said at his testimony in Congress on Nov. 30.
Since those comments, the November jobs and inflation numbers have come out. The jobs report presented mixed signals, with the number of jobs created last month far below the consensus, but the unemployment rate better than expected (at 4.2%, approaching its prepandemic rate of 3.5%) and an improved labor force participation rate.
The consumer price index, which gauges inflation, jumped the most in 39 years in November, but came in about as expected. Especially with the jobs number, keep in mind that month-to-month numbers can be volatile. For example, the number of jobs created in November could be revised up when the December numbers come out in early January.
The inflation report "confirms that the Fed is on track to begin hiking rates at some point next year," Sarah House, senior economist at Wells Fargo told Bloomberg News. "I think this keeps them on track to see the dots move up pretty notably when we get the forecast next week."
The strong November CPI data "only solidify the case for a faster tapering of asset purchases," Rubeela Farooqi, Highway Frequency Economics' chief U.S. economist, told Reuters. "More important will be Chair Powell's message on tightening of policy going forward."
"I think that their plan right now probably is three rate hikes next year, four rate hikes in 2023," David Kelly, J.P. Morgan Asset Management chief global strategist, said in an interview on Bloomberg Television.
In the September meeting dot-plot, most Fed officials expected the first rate increase in 2023, with a few pulling the first rate hike to 2022.
The federal funds rate target range currently stands at 0.0%-0.25%. The central bankers said it expected to increase its Treasury holdings by at least $60B per month and increase it agency MBS holdings by at least $30B month, down from its prior pace of $80B of Treasurys and $40B of MBS in October.
The CME FedWatch tool shows that more traders are pulling up their expectation for a rate hike. The probability of a 25-50 basis-point rate hike for the March meeting rises to 34.2%, up from a 25.9% probability a week ago.
The probability of a 25-50 bps hike in May increased to 43.2% from 38.4% a week ago, and there's a 13.1% probability of a 50-75 bps increase.
SGH Macro Advisors Chief U.S. Economist Tim Duy sees a "high probability that the Fed hikes rates in March," although he doesn't expect the policymakers will pencil in that timeline on the dot-plot. "Where the Fed is now and where the Fed is in three months are two different things," he wrote in a note dated Dec. 7.
SA contributor John M. Mason sees complications in the Fed's taper due to the massive amounts of reverse repurchase agreements it has used to keep the effective federal funds rate positive.