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February 2022 Economic and Interest Rate Projections
by Craig Dismuke, Dudley Carter
Supply Chain Disruption and Labor Shortage Take a Toll on Outlook: The persistence of the supply chain disruption and lack of labor supply has led to an acceleration and broadening of consumer inflation. While goods inflation is likely to ease in coming quarters as the supply chain heals and elevated demand moderates, services inflation is now expected to keep overall inflation uncomfortably high. We now expect this faster inflation environment will drive the Fed to liftoff monetary policy more abruptly. We continue to expect the policy tightening to negatively affect financial conditions, and even more so given the faster liftoff; although, we now believe the Fed will be more tolerant of this given how pervasive the inflation pressure has become.
Inflation Expectations and Likelihood of Emergency Policy Actions: Given the heat and breadth of the inflation data, the question of emergency policy actions has been raised. We see the likelihood of this as low so long as longer-term inflation expectations remain near 2 percent. Keeping longer-term inflation expectations anchored is of paramount importance to Fed officials given the potential impact an unanchoring would have on longer-term interest rates, and the resulting economic damage. If cracks emerge in this confidence, emergency policy decisions would be more likely.
Faster Liftoff and More Tenuous Economic Environment Expected: Against the backdrop of hotter inflation and a faster monetary policy liftoff, we have made notable revisions to our growth and interest rate projections. We now expect inflation to average 4.2% in 2022, dragging an additional 0.7% from nominal growth. Also negatively affecting headline GDP, much of the inventory turnaround which was expected to provide a tailwind to growth this year occurred in 4Q21. As a result, we now expect the economy to expand 2.5% in 2022. To keep inflation expectations anchored, we expect the Fed to hike as aggressively as the market will allow in the first half of 2022 before slowing the pace in 4Q. However, we expect this more aggressive pace of liftoff to increase the risks to an eventual policy misstep.
February 2022 Economic and Interest Rate Projections