Are rate hike expectations in-line with inflation and GDP expectations?
The market has priced in the US raising the Fed Funds rate to 3% by next year. I compare this to the EUR policy rates that are priced in, which appear to be less aggressive. Furthermore, I compare the consensus forecast of Bloomberg contributors for inflation (YoY CPI) and economic growth (Real GDP). Are there inconsistencies?
First, I compare the 1month implied forward OIS (overnight index swap) rates between USD and EUR shows that the US will be more aggressive at rising rates to fight inflation.
Plotting the above forward rate projections below, one can see that the USD OIS curve has priced in a more aggressive rate hike than for EUR OIS with US being far more aggressive in 2022. One can see the difference between US 1M rates vs EUR 1M rates going from just over 100bps today to 250bps by end of 2022 before coming back down to the 100bps level in 2026–2027.
Next, I compare the CPI and GDP forecasts between US and EUR based on the contributor composite in Bloomberg. It appears US has observed higher YoY CPI but overall GDP has also been stronger in 2021. The CPI forecasts seems to assume US CPI will converge with EUR by end of 2022. Perhaps, this is a reaction from the impact of more aggressive rate policy?
I do not know if the inflation expectations of the economists are pricing in the same rate hikes as the curves (there’s often timing differences as economists update their forecasts whenever the markets have a substantial shift) but economists are often wrong and implied forwards often fail to be realized (i.e. the implied forward rate is just a view of what rate hikes are priced in by the market, rather than a forecast of what would actually happen).
Personally, I do believe the Fed will be much more aggressive on rate hikes then previous rate cycles given the high inflation and the need for the Fed to assert itself as trying to show they are doing something to control it. Whether it will be successful at it and whether the economy can sustain it without entering a severe recession is yet to be determined. I would just add that the high inflation we have observed is not a localized issue and that I would expect the central banks to keep a close eye on each other’s policy actions to gauge their relative effectiveness.