Most US Federal Reserve officials agreed at their meeting in May that the central bank needed to tighten in half-point steps over the next couple of meetings, continuing an aggressive set of moves that would leave policy makers with flexibility to shift gears later if needed. The Fed updated their forecast for inflation as measured by the PCE of 4.3% in 2022 but they lowered their forecast to 2.5% in 2023 and 2.1% in 2024. If their forecast is accurate, it would imply the next expected three half-point rate hikes could be the end of the current tightening cycle and set the stage for a major risk rally into second half of 2022. The market has reduced the number of quarter point rates for this year to 7.
Chart 1: The number of rate hikes priced for 2022
Thirty-year mortgage rates fell for a second week in the US. Rates are now 5.29%, the lowest in 4-weeks. That’s down from the peak of 5.57% on May 12, the highest since 2009 and compares with 3.3% at the start of the year. Rises in lending rates has caused home buyers to back away and mortgage origination to slow recently. And April data showed housing starts, new and existing home sales, as well as pending home sales missed estimates while previous-month data was revised lower.
Chart 2: US 30-year fixed mortgage rate (%)
Inflation expectations in the US bond market are subsiding despite the recent resurgence in the commodity complex. That aligns well with the perception that the risk of recession is increasing. At some point supply-shock-driven inflation is likely to bring about its own demise via demand destruction, and bond investors look to be signalling we are getting close to a turning point for broad price gains even if wheat and crude stay elevated.
Chart 3: Market expectation of inflation fall (%)