The authors are economists from Shinhan Investment Corp. They can be contacted at [email protected] — Ed.
Price markets on expectation of six rate hikes (+150bp) this year
Monetary tightening fears have risen since the start of 2022, with financial markets now priced in to expectations of six Fed rate hikes this year versus late-2021 forecasts of just two. The upward revision to the US consumer price index (CPI) forecast at the end of 2021, reflecting cost inflationary pressure from supply chain disruptions, high wages and geopolitical tensions, raised fears of a potentially faster pace of policy normalization.
Cost inflation is approaching a peak but demand pressure is growing rapidly
We are now seeing signs of supply-side inflationary pressure peaking, with indicators showing that the worst of the supply chain disruptions is coming to an end. Labor market imbalances have started to narrow. Unit labor costs have peaked and should cease to exert upward pressure on selling prices. Commodity prices, which have risen sharply due to growing geopolitical tensions, are expected to stabilize in the short term. Stable oil prices will likely contribute to a 0.1-0.2%p decline in average monthly CPI growth.
While cost-driven inflation is expected to peak in 1Q22, we see demand-driven inflationary pressures rising faster than expected. With the normalization of economic activities and pent up purchasing power to stimulate demand for services, we expect high inflationary pressure to persist throughout the year.
US Fed policy normalization will continue as high inflation persists
Until the end of 2021, monetary tightening was seen as a necessary step to allay inflation fears. Once inflation slowed after a rate hike, the US Fed needed to adjust the pace of policy normalization. Today, however, growing inflationary pressure from the demand side calls for preemptive measures from the powerhouse to fight inflation. Assuming that the Fed will continue its policy of tightening, we expect an increase in the key rate of 75 basis points in 1H22 and more than 50 basis points with reduction measures in 2H22. As the actual pace of policy normalization will depend on the economic recovery, faster monetary tightening should have a limited impact overall.