Based on the higher-than-expected inflation print on Friday and the hawkish comments from influential NY Fed president William C. Dudley, we change our call and now expect the Fed to deliver the next hike at the March meeting. Markets have now priced in an 85% probability of a March hike and given that markets are calm and growth remains strong, it seems like a good time to hike.
However, do not necessarily expect the Fed to change its communication at the upcoming meeting on 31 January, as this is one of the small meetings without updated projections and a press conference. The accompanying statement usually does not change much from meeting to meeting. More important are the individual speeches.
We also change our call and now expect three hikes (previously two) with the second hike likely in June and the third one in December (obviously it is a bit difficult to distribute three hikes throughout the year, as the Fed so far has been reluctant to move on one of the smaller meetings). The three hikes are in line with the Fed's dots and consensus among economists. Markets have priced in a 50/50 probability of another Fed hike in June.
While we expect the Fed to hike three times, we maintain our view that inflation pressure will remain subdued, although it is likely to increase from current low levels, and hence we think it is unlikely that the Fed is going to hike more than it is currently signalling (three hikes). However, the Fed is still tightening, as the FOMC members have a strong belief in the Phillips curve theory suggesting that the tighter labour market will eventually push wage growth higher, and also they have a tendency to put more weight on labour market data than inflation.
It is worth noting that the discussions among the FOMC members on why inflation has run below the 2% target persistently are intensifying and inflation will remain an important market theme this year.
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