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Jan. 22, 2022, 11:12 a.m. EST

The Federal Reserve’s first meeting of 2022 looms as risk of inflation outside of policy makers’ control builds

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By Vivien Lou Chen

The Federal Reserve’s first meeting of the new year kicks off next week, just as price pressures outside of the central bank’s control may be growing.

Some of that pressure is coming from a possible invasion of Ukraine by Russia, one of the world’s biggest oil producers — which could provoke a further escalation of gas prices in Europe and help send U.S. oil prices to $100 a barrel soon for the first time since 2014.

Another source is climate change , which is impacting the availability of lumber and contributing to an 81% gain in the commodity’s price over the past year. Even a Supreme Court’s decision last year that allowed evictions to resume across the U.S. is being cited as a cause for anxiety. Read: Oil prices may soon rise to $100 a barrel. Here’s why and America’s housing market is in the grip of an inflation storm

Fed policy makers are likely to spend their Jan. 25-26 meeting  laying the groundwork  for a shift away from an easy-money stance this year, without taking policy action. While they are likely to reaffirm investors’ expectations for an interest-rate increase in March, the first hike since December 2018, Fed officials are not expected to tinker with policy rates, currently between 0% and 0.25%, for now or start shrinking their almost $8.9 trillion balance sheet until probably after June, following the end of their current bond buying program in March.“They have plenty of ammunition to deliver three or four hikes this year, but there is a question about whether that will be fast enough or big enough to control inflation,” said Daniel Tenengauzer, head of markets strategy and insights for BNY Mellon in New York. “We are particularly worried about housing” since the end of the moratorium on evictions means a risk premium is being added to rental contracts for newcomers, while “geopolitical risk will put pressures on all energy items.”Wednesday’s Fed policy statement is likely to sound hawkish on inflation and should, along with the meeting minutes released three weeks later, reveal more details about the future of the Fed’s balance sheet, Tenengauzer said via phone. He says a 50-basis-point hike is possible, though unlikely, in March. Meanwhile, JPMorgan & Chase’s Michael Feroli says the Fed is more likely to retain the option to hike at every meeting, rather than deliver a half-point hike in March, and he sees a one-in-four chance the central bank completely stops purchasing assets in February.

The Fed, economists and many traders are all counting on inflation to fall off by year-end, helped by fading pandemic-related base effects.Still up for some debate, though, is whether rate hikes and a smaller Fed balance sheet will be enough to counter the forces that may keep inflation up. By the time the Fed hikes at its March 15-16 meeting, consumer price reports for January and February are likely to reflect annual headline rates above 7.2% each month, according to traders. In the past week, fears about a Russian invasion of Ukraine have mounted, while the impact of high lumber prices has spread. China’s zero-tolerance approach toward COVID-19 is aggravating concerns about supply-chain disruptions. All this comes after gains in December’s U.S. consumer-price index that pushed the annual inflation rate to 7% showed the cost of rent rising fast.“Asset purchases were a tool used against the Covid crisis, but tapering them or shrinking the Fed’s balance sheet are totally ineffective against inflation,” said portfolio manager Eric Vanraes of Eric Sturdza Investments in Geneva. “The only tool to fight against inflation is a rate hike.”Vanraes, whose firm oversaw $2.8 billion as of last year, says he’s convinced long-term deflationary forces, such as globalization and demographic aging, will prevail and help bring down inflationary pressures by no later than the first quarter of 2023.He’s positioning ahead of next week’s Fed meeting by buying 30-year Treasurys /zigman2/quotes/211347052/realtime BX:TMUBMUSD30Y +0.09% in anticipation of a rally in the long-dated note during the second half. In addition, Vanraes says he’s partially hedging the firm’s allocation of investment-grade bonds with 10-year futures /zigman2/quotes/210369575/delayed TY00 -0.04% , considering the 10-year rate could climb to as high as 2% this year as the Fed hikes rates.Long before the Fed’s first hike, investors have reacted to the Fed’s hawkish pivot by tightening financial conditions: The 10-year /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +0.68% has climbed more than 20 basis points in 2022, the biggest advance to a new year since 2009; the 30-year inflation-adjusted yield has risen 47 basis points, to minus 0.128%, since December, according to Tradeweb; and corporate credit default swaps have widened.Economists at Credit Suisse Group AG /zigman2/quotes/202835784/composite CS +1.81% expect core personal-consumption expenditures price index — a key gauge watched by the Fed — to stay well above 2% by year-end, says Jonathan Cohn, head of rates trading strategy in New York. He says rising wage pressures would be the most likely reason for inflation to persist. “The Fed has pivoted fairly quickly from not thinking about hikes in 2022, to accelerating tapering in order to hike earlier, showing a greater sensitivity to the inflation backdrop,” Cohn said via phone. “I think gesturing toward a willingness to do what’s necessary helps.”On Friday, U.S. equity gauges closed out a punishing week, with Dow industrials /zigman2/quotes/210598065/realtime DJIA -0.75% , the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.58% and Nasdaq Composite /zigman2/quotes/210598365/realtime COMP -0.26% posting their biggest weekly percentage drops since 2020.Next week’s economic calendar brings Monday’s release of IHS Markit’s purchasing managers indexes. S&P Case-Shiller’s national home price index for November and January’s consumer confidence index are released Tuesday.An advance report on trade in goods and data on new home sales starts arrive Wednesday. Thursday brings weekly jobless claims, December durable goods orders, and a reading on fourth-quarter GDP. Friday’s data includes December’s PCE inflation readings and consumer spending, along with the University of Michigan’s consumer sentiment index. Sign up for our Market Watch Newsletters here Myra P. Saefong contributed to this article.

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