It’s Beginning to Look a Lot Like

kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
12/15/2021

The final FOMC meeting for 2021 is now in the books and the money and bond markets are poised to turn the calendar. If you think about where monetary policy expectations were to begin this year, or even just three to six months ago for that matter, it has been a notable transformation. If you had broached the idea that the Fed would be raising rates in 2022, let alone multiple times, your argument would have been dismissed out of hand. But now, it’s beginning to look a lot like rate hikes may be coming next year.

First, though, the Fed needs to finish up some balance sheet business—tapering. The December FOMC meeting laid the groundwork for the Fed to end their tapering process sooner than originally outlined. Once this part of their exit strategy ends, the policy makers will need to decide on what to do with their holdings of Treasury and mortgage-backed securities when they mature. In my opinion, the first step will be to roll over the proceeds of the maturing debt on the Fed’s balance sheet and re-visit this issue later on. 

That brings us to the ultimate headline-maker, liftoff. Until now, Chairman Powell had basically given the thought of rate hikes the proverbial Heisman. To quote him from the November FOMC presser, the “rates-liftoff question isn’t before us now.” My, how things have changed in six weeks’ time. Indeed, the blue dots (the Fed’s projections for Fed Funds) have now shifted to 2022 for the median estimate. Remember when the first rate hike wasn’t expected until after 2023? 

The question before the markets now seems to be when is actual liftoff, and how many rate hikes to expect? In my opinion, Chairman Powell needs to provide that forward guidance in order to avoid any surprises and/or misinterpretations. As of this writing, the implied probability for fed funds futures is looking at Q2 (May/June) as the start date and around two to three rate hikes for 2022 as a whole.

Lately, there has also been some concern about a potential policy mistake or the Fed becoming too hawkish. Utilizing Powell’s prior bout of rate hiking as a guide, I feel the Fed will be deliberate in their rate-hiking approach, at least to begin with. Then, if inflation continues to run ‘too hot’ (as is the present case), the policy makers may take a more aggressive turn.

Conclusion

Where does that leave us? Quite simply, rising rates is our primary theme for 2022. In our most recent Office Hours, on the inflation front, we asked advisors if rate hedging had become a priority for the bond portion of their portfolios. A little more than 40% answered: Not yet, but they are actively considering it. 

Advisors may want to start implementing such solutions now, because as we’ve seen this year, Fed policy could look much different in the months ahead than what is currently expected.

Related Blogs

Fed Watch: Moving On…and Rather Quickly

Fed Watch: “Exit Stage Left”

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WisdomTree Yield Enhanced U.S. Aggregate Bond Fund

WisdomTree Floating Rate Treasury Fund

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About the Contributor
kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was most recently a Managing Director. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.