Federal Reserve's Christopher Waller said three hikes in 2022 are still a good baseline but he said if inflation stays high there could be four or even five hikes.

Key notes

Could also allow the balance sheet to run off earlier.

Doesn't favour 50bps Fed hike in March.

Could start shrinking Fed balance sheet by summer.

Can shrink balance sheet by allowing organic runoff.

Expect inflation around 2.5% by end of 2022.

Once inflation down to 2.5% rapid rate hikes no longer needed.

Fed can take action on balance sheet to prevent yield curve flattening if needed.

Inflation has stayed higher for longer than any of us thought it would.

Fed has to be ready to make quick changes in direction, speed, depending on data.

If inflation stays above 3%, clearly we would need to do more, and potentially rethink framework.

High inflation caught us off guard in what it implies for framework.

Market implications

After Fed's Williams on Friday, Fed speakers will then enter blackout on communications this weekend and the markets are already expecting a rate increase as soon as the end of this quarter. The Fed has guided that rates can start to go up as soon as March.

However, the balance sheet runoff has been rethought by my markets this week, with some members suggesting it will not happen until late in the year or next year. This has stripped US yields and the US dollar lower. Waller is on the more hawkish side, however,

Meanwhile, the US dollar, as measured by the DXY index, has moved in on a critical level of daily support and would now be expected to correct higher as follows: