by Paul Hoffmeister, Chief Economist
Expectations of rate hikes this year have exploded higher.
Correlates with the jump in statistical inflation to a new, higher range since October.
Russia to pursue largest military land operation since 1945?
While Russia annexed Crimea in February-March 2014, gold prices jumped more than 10%.
Expectations of how much the Federal Reserve is going to raise interest rates this year have exploded higher. According to the Chicago Board of Trade, the December 2022 fed funds future is suggesting that the federal funds rate, which now trades around 8 basis points, will be nearly 137 basis points in December. This implies that the FOMC will raise the overnight lending rate by a quarter point at least 5 times in the coming months.
What’s especially notable about these expectations is how quickly they’ve changed during the last three months. In early October 2021, the December 2022 fed funds future indicated that the market was only 1 quarter point increase this year.
What’s behind this major shift? In our view, it’s partly due to the recovering economy following the global shutdown in Q2 2020. Prior to the pandemic, according to the Bureau of Labor Statistics, the U.S. unemployment rate was 3.5%; today, it’s 4.0%. But even more, statistical inflation began to break out in October 2021. Specifically, the core Personal Consumption Expenditures Index according to the Bureau of Economic Analysis began to rise from a 3.6% year-over-year increase to 4.9% today.
Since the breakout of inflation in October to a new, higher range, the Federal Reserve has communicated a series of hawkish policy changes ahead. For example, on November 3, the FOMC announced that it would reduce the pace of bond purchases, which suggested that its quantitative easing program would end by mid-2022. On November 30, Chairman Powell acknowledged that “it’s probably a good time to retire [the word transitory] and the bond taper may need to conclude a “few months sooner”. On December 15, the FOMC announced the plan to conclude its bond buying program in March. Then, on January 26, the FOMC statement read: “With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”
A rate increase in March, following the FOMC’s March 15-16 meeting, seems to many to be a fait accompli. Underscoring the speed in which expectations have changed recently, the prospect of a March increase was highly unlikely based how fed funds futures were trading last October.
Ukraine: Senior U.S. military and state department officials briefed the House and Senate in closed door meetings last Thursday. According to the New York Times, lawmakers were informed that Russia has assembled 70% of the forces necessary to mount a full-scale invasion of Ukraine, which “would constitute the largest military operation on land in Europe since 1945.” Some officials believe that were Russia to invade, it would not occur until the second half of February, so as not to antagonize China’s leadership, who will be overseeing the Winter Olympics in Beijing. Furthermore, it would allow the ground to freeze even more, making it easier to move heavy equipment and vehicles. Officials outlined 5 provocative scenarios that President Putin could undertake in Ukraine, from a coup or limited incursion to a larger scale invasion to take over most of the country.[i]
President Biden has ordered 3000 troops to Eastern Europe in countries bordering Ukraine, but he insists they will not go into Ukraine.[ii] And, according to the New York Times, American and European officials have warned of “sanctions on Russia’s banks, trade restrictions on semiconductors and other high-tech items and the freezing of the accounts of Russian oligarchs and leaders.”
What does this mean for investors? We don’t believe this issue will be resolved anytime soon and will likely linger for a long time. Furthermore, geopolitical variables can be enormously complex and unpredictable, and similar periods of time can be useful for investors to navigate markets amid uncertain variables like these. When Russia annexed Crimea in 2014, the S&P 500 returned over 5% between in February and March, but we’d emphasize that stocks were then coming off a very weak January. Additionally, gold prices jumped from approximately $1250 in early February 2014 to more than $1380 in March 2014.
[i] “US warns of grim toll if Putin pursues full invasion of Ukraine,” by Helene Cooper and David Sanger, February 5, 2022, New York Times.
[ii] “Biden moving US troops in Eastern Europe won’t prevent Russian invasion, experts agree,” by Caitlin McFall, February 5, 2022, Fox News.
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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).
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