The press conference which followed the Federal Reserve’s meeting on 26 January continues to reverberate around the market. US stock indices dropped more than 1% and bond yields moved higher in the immediate aftermath to reflect a tougher line on interest rate hikes.

The message dashed any hope that falling stock prices and increased volatility (how much prices move around) might influence the Fed to moderate its view on tightening up its policy on financial stimulus and rates.

Bond markets have since priced in more interest rate increases while economists at Bank of America are now expecting seven rate hikes in 2022.

The Fed believes the economy is in such good shape that it can push rates higher without negatively impacting the labour market or risking a pronounced downturn.

Effectively the Fed said it can create a soft landing, which means slowing the economy enough while not causing a recession.

Investors will get a better idea of the strength of the labour market with the latest monthly jobs report on 4 February.

There are an increasing number of bond fund managers and economists who believe the Fed should have started to remove stimulus earlier.

They argue the Fed is now behind the curve and could tap too hard on the brakes to play ‘catch-up’ and in the process slow the economy more than intended and inadvertently cause a recession.

Most forecasters see inflation naturally falling back by the year end as base effects and reduced supply chain problems are wrung out of the system, although it is still expected to be above the Fed’s 2% target.

In addition, the strong rebound in global growth is already showing signs of moderating with the International Monetary Fund recently reducing its 2022 forecast for global growth from 4.9% to 4.5%.

With bond markets already pricing in five rate hikes for 2022 and the S&P 500 index down around 6% this year, financial conditions have arguably tightened ahead of any explicit action by the Fed.

Some froth has been taken out of the market with riskier assets and meme stocks underperforming heavily. Gamestop shares are down around 60% since November and Bitcoin is around 40% off its highs.

Investors now know rate hikes will happen, possibly in March, but there is an intriguing disconnect between the market’s view of where the Fed funds rate will peak, around 1.75% and the Fed’s view which is 2.5%.

In other words, bond investors do not anticipate more than seven rate hikes in this cycle, implying growth will quickly fall back to trend.

As we write the UK was expected to see its first back-to-back interest rate rise since 2004, with the Bank of England announcing its interest rate decision on 3 February.

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