The Federal Reserve is set to confirm its plans to raise interest rates in March for the first time since the onset of the pandemic, as the US central bank charts a more aggressive course towards monetary tightening in the face of sticky inflation.
Fed officials will convene this week for their inaugural policy meeting of 2022, the first since the central bank made its fight against rapid US consumer price growth its top priority.
The Fed has hardened its rhetoric in recent weeks about the risks posed by high inflation, with chair Jay Powell this month calling it a “severe threat” to a sustained economic expansion and a robust labour market recovery.
Its top policymakers have also made clear that they are willing to act forcefully to ensure inflation does not become ingrained, by considering raising interest rates “sooner or at a faster pace” than anticipated and swiftly shrinking the Fed’s enormous balance sheet this year.
Coupled with mounting evidence that inflation is broadening out and the labour market is quickly healing, the central bank is well placed to move in March, many Fed officials and Wall Street economists argue.
“The labour market is tight, wage inflation is elevated and price inflation is substantially elevated,” said Peter Hooper, the global head of economic research at Deutsche Bank, who worked at the Fed for almost three decades. “Do we still need to be at a crisis-level of support for the economy? No.”
Beyond confirmation that the Fed could soon raise rates, economists are also looking for more clarity on the path forward after the first adjustment. The central bank’s policy statement is set to be released on Wednesday, followed by a press conference with Powell.
Fed-watchers are split as to whether the central bank will also announce an immediate end to its asset purchase programme, which is currently set to end in March. Powell affirmed that timeline earlier this month, but according to ING, there is “no reason” for the central bank to buy any additional bonds.
In December, Fed officials coalesced around three quarter-point increases in 2022, with another three for 2023 and two in 2024. This month, however, an increasing number of policymakers have laid the groundwork for more.
One of the most hawkish officials and a voting member this year on the Federal Open Market Committee — James Bullard of St Louis — said he supports four rate rises this year. Christopher Waller, a governor, said that five could be appropriate if inflation remains elevated.
Jason Thomas, head of global research at Carlyle, went as far as arguing that seven this year is not “improbable”.
“What the Fed is going to prepare us for is for the potential for rate hikes at every meeting after January,” he said.
Some speculate the Fed could also consider raising interest rates by half a percentage point in March — something it has not done since May 2000.
Bill Nelson, former deputy director of the Fed board’s division of monetary affairs, said the central bank should “prepare the public” for that possibility this week.
“Responding to the current circumstances by being gradual is just going to leave them more and more behind the curve and ultimately will end with a very sharp correction,” said Nelson, who is now chief economist at the Bank Policy Institute. “So many people are taking too much of a signal from the very gradual tightening pace last time and not thinking about what it means to adopt a policy position appropriate for restraining the economy and bringing down inflation.”
However Jan Hatzius, chief economist at Goldman Sachs, whose forecast aligns with market expectations for four quarter-point rate rises in 2022, said such a dramatic move is both unlikely and unnecessary.
“The question is really more, do you see a string of hikes at successive meetings?” he told the Financial Times during an event hosted by the Chicago Council on Global Affairs on Thursday. “That is a possibility.”
A sudden lurch towards significantly more hawkish Fed policy that threatens to dent the growth outlook is the “key downside risk” for financial markets this year, warned Holly MacDonald, chief investment officer at Bessemer Trust.
“Success is not just killing this acute inflation. Success is getting away from [zero],” said Matt Toms, chief investment officer for fixed income at Voya Investment Management, referring to the current level of the federal funds rate. He added that the Fed should raise rates only gradually, given that inflation and growth are both expected to slow later this year.
Equity markets have swung violently in recent days as investors have digested the implications of swifter Fed tightening, with global stocks suffering their biggest declines in more than a year last week.
Economists also this week expect further details about the Fed’s plans to shrink its balance sheet, which has more than doubled in size since early 2020 and is now just below $9tn.
In its first in-depth discussion on the subject in December, the FOMC agreed to a faster reduction than the pace set after the 2008 global financial crisis.
Nancy Vanden Houten, lead economist at Oxford Economics, predicts the Fed will eventually institute monthly redemption caps of $30bn for Treasuries and $15bn for agency mortgage-backed securities in the third quarter, and later raise those to $60bn and $30bn, respectively.
At that pace, the balance sheet would slip below $6tn in 2025, according to her estimates.
Source: Economy - ft.com
