Federal Reserve Chairman Jerome Powell listens to a hearing of the Senate Banking Committee on the Quarterly CARES Act Report to Congress on Capitol Hill in Washington, United States, on Dec. 1, 2020.

Susan Walsh | Reuters

With the economy booming over the next few months, the Fed will have a harder time defending its super-easy policy.

Economists expect the second quarter to grow more than 9%, and the monthly job reports are likely to have a very strong mindset. Employment growth will average more than 1 million new employees over the next few months.

Even the reaction to the surprisingly strong job report from March could be a sign of further developments. Friday’s March report showed the number of new jobs rose to 916,000, nearly 250,000 more than expected.

After the data was released on Friday, the Fed funds futures market immediately began moving forward expectations for a rate hike by the Fed to December 2022 from spring 2023.

“Friday brought us to the other side,” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. “That’s a full year before where the [Fed forecasts] tell us that the majority of the committee is. They still consider 2024 their first hike. “

Jim Caron, head of global macro strategy at Morgan Stanley Investment Management, said the Fed is facing one of its toughest tests of all time.

Last year the Fed introduced a new inflation policy in which it would tolerate an inflation margin on either side of its 2% target. The Fed has to defend its zero interest rate policy, and its bond-buying program as a whole wave of data shows a sharp spike in economic activity and inflation that could rise well above 2%, at least temporarily.

Due to the economic shutdowns a year ago, inflation could look hot this spring compared to the low base a year ago. Fed chairman Jerome Powell said the Fed expects inflation to rise temporarily, but some in the market are expecting higher levels of inflation based on increasing demand as well as government stimulus.

“You will be going through the glove now. You will be going through the hardest part of the glove in April and May,” said Caron. “The data will be good. This quarter will test your credibility … The second quarter will be plus 10% growth and inflation will hit the core PCE by 2.5% and they will.” say, ‘this is fleeting.’ “

Further signs of inflation are imminent

When the data gets better, the Fed’s job will get even harder. The consumer price index will be released next week and could already show signs of inflation based on comparisons with the decline in many prices in March last year. February CPI rose 1.7%, the largest increase since the start of the year.

“They want a full recovery and they will wait and see. That is, the concern is not just what we are suggesting, but whether you are getting additional suggestion for the infrastructure,” said Diane Swonk, Chief Economist at Grant Thornton. “The Fed won’t include that in their forecast until they see it, but the bond market is leading the way.”

Swonk said the inflation data could be very strong with a CPI above 3% and some components within the data peaks. “Used vehicles are going to grow 35% year over year because they were down a year ago. There is potential for some really strange numbers,” she said.

Government bond yields have risen on the back of economic optimism, inflation expectations and stimulus spending, which should increase the supply of government bonds and stimulate the economy. Congress recently passed a $ 1.9 trillion stimulus package and some of the money went into the economy. President Joe Biden unveiled a $ 2 trillion infrastructure plan last week.

The benchmark 10-year treasury affecting mortgages and other credit was 1.71% on Monday. It rose by around 90 basis points in the first quarter.

The 2 year rate of return has also increased lately. According to the employment report, it rose to nearly 0.18%, its highest level in 14 months. Yields move against price, and the 2-year yield better reflects the Fed’s interest rate intentions than the 10-year yield. The 2 season was 0.16%

Caron said economic data will keep getting better for a while as states reopen and vaccinations increase. The market could continue to push on the Fed, but it expects Fed officials to stick with the first rate hike through 2024.

“This is a policy-driven market and policy makers are very important right now,” he said.

Michael Schumacher, director of tariffs at Wells Fargo, said the market is anticipating more than three rate hikes in total in 2023.

“The market is calculating a lot of interest rate increases,” said Schumacher. He said the market is struggling to process the strong data and expectations for the next few months.

“I suspect the market is throwing in more and more rate hikes. The question then is, what is Powell doing?” he said. “The point is, we can see the numbers, but no one else has taken that route. The response function is new. This idea of ‚Äč‚Äčtargeting inflation is new. What if inflation rises well above 2%? The Fed will got a lot of it. ” Heat.”

Taper?

Before the Fed even thinks about a rate hike, it is expected to repay the $ 120 billion monthly in government bonds and mortgages it buys.

Mark Cabana, head of short US rates strategy at Bank of America, believes the Fed will signal its intention to scale back the program soon and that purchases could slow down in December, just under a year before they should begin to raise interest rates.

“There is a real chance that in the near future the Fed will begin to change its minds and show real progress,” Cabana said. “This week’s minutes will be interesting in that regard. The guidance on ‘Substantial Further Progress’ has been very vague … you need to start setting the stage soon.”

The Fed released the minutes of its last meeting on Wednesday afternoon. The Fed has announced that it will continue its asset purchases at its current pace until it sees progress in the economy and the labor market.

Cabana said the Fed should fully trim its asset buybacks before raising rates, and he believes the market is too aggressive at the time of the first rate. But he expects the Fed to rise aggressively once it starts.

Cabana said the past few minutes had already shown a divided view within the Fed, and that could increase as stronger economic data comes out. For example, Dallas Fed President Robert Kaplan identified himself as one of the officials in the Fed’s anonymous forecast that in his case in 2022 would like an earlier rate hike than the consensus rate.

“The core dominates … There are basically two camps and the core is most important,” Cabana said. But he expects the discontent to grow louder.

Grant Thorntons Swonk also expects dissenters’ voices to rise as economic data improves. “The [regional Fed] Presidents are getting a little more nervous and that will create dissonance. The news is getting harder, “she said.

Boockvar said the market should keep moving ahead of the Fed.

“This is the market that says we are one step ahead of the Fed,” said Boockvar. “The market will pull the Fed into tightening at some point. Regardless of how cautious the Fed wants to sound, the market is starting to make adjustments for it.”