Source: Call of Duty/Infinity Ward

By Michael O’Neill

Will “entrenched” become the 2022 “transitory”, to describe inflation?

Fed Chair Jerome Powell first used “entrenched” at the Senate Committee hearing on Banking in December, when he also said it was time to retire “transitory” from Fed communiques.

He repeated the term in his opening remarks at his confirmation hearing this week, when he said “We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.

Transitory was the 2021 “go-to word” to describe inflation.  Mr Powell described it as a word that had different meanings to different people. For the Fed, it meant “it won’t leave a permanent mark in the form of higher inflation.”

He did not provide a Fed definition for entrenched. However, the Cambridge Dictionary was up to the task defining it as “established firmly so that it cannot be changed.”  Synonyms include embedded, deep-rooted, and fixed.

That suggests the Fed will react aggressively to signs inflation is becoming entrenched, one of which will be a January CPI reading above the latest 7.0% y/y result.

Inflation is why December’s Fed dot-plot projections showed three rate increases in 2022. Goldman Sachs, JPMorgan, and Deutsche Bank analysts are a tad more aggressive.  They expect four rate hikes. If they are correct, the target range for Fed funds will increase from 0-0.25% to 1-1.25%.

Does it really matter?

Will raising interest rates from near zero to “really low” wreak havoc? Will it kick off a new recession, trigger massive job losses, crush the housing market, or put an end to mergers and acquisitions? Will stock markets collapse and Treasury yields soar?

Not likely!

It is hard to see investors dumping stocks for the safety of government bonds or bank GIC’s.

The S&P 500 gained 26.9% in 2021 and has an 8.3% % average yield since 2001. US 10 year Treasury yields were 1.71% on January 12, 2022 and yielded an average of 3.10% in the same period.

Source: IFXA Ltd and

The Canadian story isn’t much different. A 10-year Government of Canada bond yields 1.70%. The TSX index average return in 2021 is 25.1%, and the 20-year average return is 8.4%.

A 1.0% rate hike in Canada or the US will not spark mass lay-offs, housing market turmoil, or an equity market collapse. Far from it.

Employers in both countries are scrambling to add workers and have resorted to wage increases, hiring bonuses, and other incentives to attract workers.

The Canadian housing market is insulated from rising rates to a degree due to recent government regulations for mortgage stress tests and other measures in addition to a housing shortage in many urban centers.

Financial market participants are not surprised that US and Canadian interest rates are rising in 2022. US inflation was 7.0% y/y in December, and Canada’s inflation rate was 4.7% in November. Both results are well above mandated target levels, which suggested action was imminent.

Central banks have warned that pandemic era stimulus programs would soon be ending, and the Bank of England (BoE) was first off the mark.  On December 16, It hiked the overnight rate by 0.15%, from 0.10% to 0.25%.

BoE Governor Andrew Bailey defended the increase saying, “we’re seeing things now that can threaten that. So that’s why we have to act.” The move set the stage for additional rate hikes, perhaps as soon as February.

The rate rise did not appear to accomplish anything, and it certainly did not hurt risk sentiment in the UK. The FTSE100 index gained over 5.0% since the BoE meeting.

Rate hike fears have not derailed US stocks. The S&P 500 is close to where it closed on December 31, which is impressive after the FOMC minutes first revealed a hawkish Fed bias.

The prospect of higher interest rates in the US and other G-10 countries has not dampened enthusiasm for commodities. The BoC Commodity Price Index jumped 28% in 2021, with further gains expected in 2022.

That’s good news for the Canadian dollar. West Texas Intermediate targets gains to $100.00/barrel in the next six months, which is also inflationary and suggests higher Canadian interest rates.

The Bank of Canada may raise the overnight rate by 0.25% to 0.50% as soon as the January 26 meeting. If so, it would be a surprise to more than a few players as many analysts predict the first hike in March. Higher Canadian interest rates and rising oil prices would target the USDCAD 1.2000 level,

USDCAD losses due to higher Canadian interest rates and high oil prices may be limited by a robust greenback.  That’s because steadily rising US interest rates and a faster pace of quantitative tightening will fuel demand for US dollars at the expense of the other G-10 currencies.

If so, traders will be worrying about an entrenched US dollar and not entrenched inflation.