Local outbreak cycles around the world diverged, owing in part to vaccine inequity, and supply chain disruptions persisted for longer than expected. The reopening of international borders was slow and halting. As a result, US inflation rates trended consistently higher through 2021, hitting 7% in December, the highest since 1982.
Stock and bond markets have had a tumultuous start to the new year, buffeted by a drastic shift in interest rate expectations. As late as in October 2021, US interest rate futures were indicating the probability of just one rate hike of 25 basis points in 2022. Now, investors are betting on four and perhaps even five rate hikes. What is driving this sharp pivot in expectations?
The US Federal Reserve has sold markets on the belief that “inflation is transitory” for much of the past two years. We too agreed with this view — that higher prices were due to manufacturing, supply chain and logistics disruptions resulting from the pandemic and border closures. Such price increases — such as for used cars as chip shortages led to new car production cutbacks — would be temporary by nature. We were wrong, but only just and we will elaborate later.
