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Fed is 'very hawkish' recently, as many as 4 rate hikes in 2022 make sense: strategist

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Wells Fargo Senior Macro Strategist Zach Griffiths joins Yahoo Finance Live to discuss what to expect with Federal Reserve rate hikes forecasted in 2022.

Video Transcript

- I want to pivot now to the Federal Reserve because Fed Chair Jay Powell is expected to get a grilling tomorrow during his confirmation hearing on Capitol Hill. Lawmakers will want to know more about how the Fed will achieve its dual mandate of stable prices and maximum employment.

Joining us now is Zach Griffiths, Wells Fargo's Senior Macro Strategist. So Zach, always good to see you. So let's begin with that dual mandate, the Fed sort of walking this fine line here as it tries to achieve it. How many interest rate hikes do you believe we are in for in 2022?

ZACH GRIFFITHS: Yeah, Alexis. Great to be with you again. We think it's going to be a year of multiple rate hikes, something between 2 and 4 makes sense to us. And I'd say the information coming out of the Fed more recently, and the commentary both from Chairman Powell and other regional Fed presidents, has been very hawkish.

And they seem to be setting up to even consider adjusting the size of the balance sheet this year. So we think that will come after several rate hikes. We think those are in line for some time around the middle of this year, perhaps could even start as soon as March. And as far as the balance sheet reduction goes, we think that could come into play in the second half of this year, perhaps to get enacted in the first part of 2023.

- And then how is the impact of QT different this time around from 2018 and 2019?

ZACH GRIFFITHS: I'd say the big thing on our radar right now is what's going on with central banks globally. And during the 2017 to 2019 period, a lot of the QT done by the Fed was offset by bond purchases by the ECB and the Bank of Japan. And while the ECB is likely to still be buying bonds for much of 2022, if not the entire year, the BOJ has really taken a step back.

So we think that the Fed's quantitative tightening program, when it gets up and running, whether that's later this year or early next year, is going to have a larger impact on the size of major global central banks globally, and perhaps have tightening impetus on a global scale.

- Zach, do you think that the economy, the American consumer, is ready for that easy money to start to be pulled back? Because you know, we have sort of been on this high, this Fed induced high, over the past few years with all of the stimulus and with those really ultra low interest rates.

ZACH GRIFFITHS: Yeah. It's a great question, Alexis. I'd say, my short answer is, yes. And that's just because we do have a lot of the stimulus of the past two years or so still kicking around in the system. You see the financial markets are awash with cash.

Our economists think that only around a third of the stimulus that was put into consumers' pockets over the past couple of years has been spent. So there is a lot of buffer in the economy to absorb a relatively hawkish shift in monetary policy.

And I think it's going to come down to how much perhaps the equity markets react and how much the Fed is willing to tolerate as far as a drawdown in equity prices go. I suspect it's larger now than it has been over the past several years, just because you have seen such incredible asset price appreciation in response to all of this stimulus due to the COVID pandemic.

- And what is that buffer rate? When does inflation really start to get in the way. If we hit, for example, 2.5%, 3%, is that something that the economy can sustain?

ZACH GRIFFITHS: Yeah, I think that's the million dollar question. And with respect to our economics team's forecast, they don't have inflation coming down that quickly, even with a relatively stark shift in policy to the hawkish end. So we still see headline inflation around 5% as far as the CPI goes in 2022.

So while we do have a big shift and some removal of policy accommodation, enough to really shock inflation that much lower in the near term. But in 2023 is when we really see inflation returning closer to the Fed's 2% flexible average inflation target.

- And what do you expect the impact to be on the bond market? Because we're seeing today yields now at their highest level since the pandemic. We continue to see the flattening of the yield curve. So as those interest rates move higher, as the Fed continues to roll back QT, what will the impact be on yields?

ZACH GRIFFITHS: We look for the 10-year yield to be around 2% at midyear. And we look for the Treasury 2/10s curve to be 40 basis points. So overall, we have yields continuing to rise, perhaps not at the pace that we've seen so far to start the year in just a few days, the few trading days that we've had. But we do expect higher yields and a flatter curve.

Even if quantitative easing is getting kicked around, if you look at how the curve behaved last time, the impact of rate hikes were larger than that of quantitative tightening on the back end of the curve. And you even saw the term premium come down a bit.

So we do think that what's going to matter more for the shape of the curve is rate hikes. And that's going to continue to flatten it. Again, we have the 2/10s Treasury curve at 40 basis points at midyear.

- Zach, what sort of clarity are you looking from Fed Chair Jay Powell tomorrow during his testimony?

ZACH GRIFFITHS: We think it'll be interesting to hear his views and updated comments on perhaps the timing of the first rate hike. I'd say the market is certainly priced for a high probability of a March hike. I don't expect that he'll push back on that too directly.

And any additional detail on quantitative tightening perhaps is unlikely. Maybe he'll comment on it, just to say that it is something they clearly discussed at length in December. But when we went through the minutes, what struck us is it was an extensive discussion, but it seems pretty preliminary at this point.

And there are still many questions to be answered as far as how they would implement the quantitative tightening policy. They outlined how things went last time around, but didn't really make any concrete decisions on what that means for this time.

- All right. We're going to leave it there. Zach Griffiths, Wells Fargo Senior Macro Strategist. Thanks for your time today.