With wages currently growing at over 3% (and rising) and economic growth likely to move higher through 2022, the pressure on the Fed to incrementally move up the cash rate will be unavoidable.
The timing of this normalisation is important. If focused to employment levels rather than wages growth, then bond markets are likely to react to improving growth conditions and push bond rates higher. If we saw 4% to 4.5% wages growth, the 10-year US Treasury Bond rate would likely breach 3% and if wages growth were sustained at these levels, then test 4%. This would initially be jarring for markets because they seem to have settled on 10-year bond rates of 2.5% to 3% as being the pain point for the economy.
Domestically, with strong economic growth and 4% wages growth supported by long duration stimulus, the US economy is arguably more robust than markets expect and domestic pain perhaps overstated at 3%. It would be painful offshore. We would expect a higher USD and this could be difficult for emerging economies whose monetary policy shadows the US, but unlike the US, are not experiencing significant economic or wages growth. US monetary policy would likely be unwavering to external events, but mindful of financial crisis.
US equities can probably move past and absorb 10-year bond rates at 3%. The US economy is in good shape and hasn’t turn the jets on yet. It is if 10-year bond rates reach 4% that it would be painful for the economy and markets. Can the Fed manage normalisation of rates such that bond markets peak at 3%, rather than 4%? They could, but history is not kind and central banks tend to be too late and then raise too hard. History may well repeat itself through late 2022 and 2023 and the boom turns to bust.