Coming out of last week’s FOMC meeting, the Fed’s wants are becoming clearer but the implications into 2022 for asset prices, interest rates and exchange rates remain to be seen. Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley, takes a moment to consider what the Fed really wants, and how markets may provide it.

What the Fed wants, the Fed gets

“We know the Fed wants financial conditions to loosen further. Does that mean US real yields will struggle to rise, the US dollar will struggle to rally, and risky asset prices will rise? The first two are certainly possible outcomes. But even if financial conditions loosen in aggregate for a time, and then remain loose for a time thereafter, not every market is guaranteed to move in a direction associated with looser financial conditions.”

“Ultimately, we believe the easy monetary policies in place today will keep expectations for real economic growth improving. This should support investor willingness to own riskier assets while placing upward pressure on real rates.”

“Expectations for inflation should remain buoyed by expectations for strong growth, but inflation risk premiums will be influenced by factors in the supply side of the economy, like supply chains and labor force participation. We see downside risks to inflation risk premiums next year, which would place further upward pressure on real interest rates.”

“Finally, in terms of the relative growth outlook, progress in the US on COVID-19, as well as fiscal developments such as infrastructure spending, favor the US over the rest of the world. This should place upward pressure on the US dollar through the first half of next year.”

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