This way of reading the Fed minutes should spook the markets more than tapering and rate hikes
The search for a new scare to dampen demand and avoid the recession.
The market reaction to Fed’s hawkish comments from the December meeting was quite brutal yesterday: Dow down 1.1%, S&P 500 down 1.9%, Nasdaq down 3.3%. A hike as soon as March appears inevitable which is why rates have spiked, and stocks are tumbling.
Initially, the Fed will not rush to hike rates at a time when millions of workers are in flux due to Omicron. That's why a March rate hike is unlikely, and the Fed itself appears to concede this with the word "Omicron" featuring no less than 9 times in the FOMC minutes. However, the flip side is that ongoing labor shortages will only lead to even higher wages and, perhaps, the dreaded wage-inflation spiral. So while the Fed will likely delay the start of liftoff beyond March, it will then have to scramble to catch up to where it should be in the hiking cycle.
There is however a slightly different reading of the minutes that concerns me, after chairman Powell retired the characterization of inflation as “transitory” in his previous statements. That is that inflation fears have been overplayed, and the Fed was persuaded to react with a negative effect on growth stocks and Treasuries while providing extra tailwinds to bank stocks and “King Dollar”. If so, during the December meeting the FOMC members left themselves a way out to backtrack using Omicron references and its estimated impact on the “maximum employment” Fed objective (since people on sick leave can still be counted as employed although they are not all working from home etc).
Assume for a moment that Fed’s hawkish stance on inflation is driven by the Administration, serving political goals in preparation for the midterm elections. My own model for Omicron infections in the Western countries shows the current wave receding by the middle of February in the UK and US, with about 1 week delay for Europe and China and maybe by early March for Australia and New Zealand.
Basic wargaming of the setup leaves a few possible scenarios to become reality in the next 4-5 weeks :
New health scare (“Flurona”?)
Proxy conflict (Kazakhstan?)
New legislation with the stated goal of dramatically tightening U.S. biosecurity (Patriot Act ‘22 Edition?)
The search for a new scare to dampen demand and avoid the recession should worry the markets a lot more than Fed tapering and minor rates increases.