The Fed raised rates by 25bps and signaled seven hikes for 2022 following March’s policy meeting. Jim Bullard dissented in favor of a 50bps move.
“Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices and broader price pressures,” the new statement said, of the highest US inflation in a generation.
The new dots suggested policy will eventually move into restrictive territory, a view not necessarily shared by all market participants. Some are increasingly convinced that a front-loaded hiking cycle will be necessary, and that a subsequent economic downturn may compel the Fed to pivot dovish by the end of next year, if not sooner.
“The Committee has rapidly coalesced around getting rates to a more neutral setting soon, including front-loaded rate hikes,” Nomura’s econ team remarked, noting that the updated dot plot adds “fuel to what will be an important debate in coming months.”
“At this point, it’s safe to assume the Fed intends on hiking at every meeting between now and Q2 2023, getting policy to the projected terminal (notably, above the longer run projection of 2.4%),” BMO’s Ian Lyngen said. “The Fed has sealed the fate of the yield curve.”
Like the ECB, the Fed nodded to the conflict, noting that “the invasion of Ukraine by Russia is causing tremendous human and economic hardship.” “The implications for the US economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity,” the Committee added.
Most market participants see the surge in commodities triggered by Russia’s invasion prolonging America’s inflation overshoot. Even if you think a ceasefire is coming, the consequences of Vladimir Putin’s actions will reverberate for decades.
The Fed’s new projections show headline and core PCE at 4.3%/4.1% in 2022, 2.7%/2.6% in 2023 and 2.3%/2.3% in 2024, respectively. Growth will be 2.8%, 2.2% and 2%, while the unemployment rate will fall to 3.5% this year, and remain there through 2023, before ticking higher to 3.6%.
As a reminder, Americans aren’t worried about the labor market anymore. Rather, they’re worried about the price of the things they need (figure below).
Recent data suggests consumers are the least confident about their finances since the 1940s, and faith in the government’s economic policies has crumbled. Gas prices have surged, as have food bills.
During his press conference, Jerome Powell acknowledged that everyday people are currently experiencing sticker shock both at the pump and at the grocery store.
I, for one, don’t doubt his sincerity. But remember: Even the best of us are only capable of so much empathy. You can’t experience another person’s suffering. Everyone deals with hardship differently.
One thing’s for sure, Powell doesn’t belong to any of the cohorts represented on the left side of the figure (above).
After putting forth a series of “principles” for balance sheet rundown at the January meeting, the Fed provided nothing in the way of a roadmap on Wednesday, saying only that runoff would commence “at a coming meeting.” Some expected an announcement of formal caps.
As discussed here in my March FOMC preview, any decision to aggressively wind down MBS holdings is fraught with peril, even as it’s generally seen as desirable and necessary. Part and parcel of the “controlled demolition” narrative is the notion that the Fed can lean into MBS runoff in order to help cool the housing market and take the wind out of risk assets as a kind of backdoor effort to lean against services sector inflation.
But controlled demolitions only work in theory. MBS are spread product. When a price insensitive buyer begins to step away, there’s a clear contagion channel to risk assets, and managing that contagion (i.e., ensuring it doesn’t lead to disorderly price action or, say, a drop in home prices that’s too large to be described as constructive) will likely prove impossible.
In any case, the Fed will make a run at QT starting relatively soon. If past is precedent, markets will be especially sensitive to MBS rundown, and I’d also reiterate that Treasury market liquidity has deteriorated, which raises the stakes.
The figure on the left (above) shows the inflation-adjusted shadow rate, which plumbed new depths this cycle. On the right is the obligatory nod to the impact of QE and financial repression on society.
Frankly, the macro outlook is so convoluted that most debates around the “proper” course for policy are asinine. Suffice to say there’s rampant skepticism around the idea that Powell can achieve the fabled “soft landing,” even as he insisted earlier this month that benign outcomes during tightening cycles are “far more common than is generally understood.”
Some policymakers previously nodded to the prospect of taking rates into restrictive territory in order to quell inflation. That’s now the plan. Personally, I doubt the Fed has the fortitude to persist long enough to get beyond neutral. That won’t be a smooth journey, and the economy could well fall into a technical recession along the way. That’s what happens when you wait too long to embark.
That said, two things are straightforward. First, rates need to rise. Irrespective of whether monetary policy can actually do much to address the shortages and myriad supply-side frictions pushing prices higher, keeping rates at zero and flooding the system with liquidity when inflation is the hottest in 40 years and nominal growth is (or at least was) elevated, is nonsensical. If that’s an appropriate approach to policy, then everything we’ve ever professed to know about economics is wrong.
Second, the Fed’s credibility is in jeopardy, and not necessarily because their forecasts were disastrously wrong or even because their best efforts to rein in inflation might ultimately come to nothing considering the nature of the problem. Rather, their credibility is in jeopardy because until Wednesday, they hadn’t taken any meaningful action in pursuit of their price stability mandate despite publicly recognizing the severity of the inflation problem.
People forgive mistakes. And they’ll forgive impotence too. But they won’t forgive a total dereliction of duty. The Fed on Wednesday said it “anticipates that ongoing increases” in rates “will be appropriate.”
“The Committee has rapidly coalesced around getting rates to a more neutral setting soon,….”
Do we know what level is a more neutral setting? Or is ANY move in that direction considered a more neutral setting?
Sorry, I’m confused. Where in the Fed Charter does it say that they are required to guarantee bond investors a real return?
Absurd & moronic, embarrassing
Powell wants you to know he has tools. All the tools. Every tool. And he’s prepared to use them, you know, when the time comes. Whenever that is.
Should the fed have started tightening earlier? In hindsight, yes. Is the fed behind the curve, of course not…
?
Has there ever been a promised soft landing? It seems that soft landings only occur in the early stages of a hard landing.
Ha. This is spot-on.
Three sentences after saying that raising rates could likely cause a recession, you say to keep rates low would be nonsensical “because it would mean everything we know about economics is wrong.” That’s some serious cognitive dissonance. I’m not trying to make this a personal attack, I appreciate your analysis and I know this is an opinion shared by lots of respectable folks, but listen to what you’re saying. “It’ll probably cause a recession, but to do otherwise would mean admitting we’ve been wrong for a long time.” WTF, man?
Why isn’t their credibility in jeopardy for doing the same thing they always do, to predictable results? Are we seriously supposed to applaud the Fed for “taking action” that you (and most, I imagine) are predicting will lead to a recession? I mean, look at the Fed’s refusal to talk about the more arcane aspect of a runoff — near silence! The Fed itself knows this is a fool’s errand. So when we talk about “credibility,” do we really mean we don’t want the general public to take a peak behind the curtain? Much like the Supreme Court, this is all about optics? Can’t let people know that the court doesn’t actually just call balls and strikes; can’t let the general public know that monetary policy is mostly inept without adequate fiscal policy. This is all just pure showmanship.
“I’m not trying to make this a personal attack.”
Good idea.
The slower they go the more permanent the inflation the faster the dollar ceases to be the reserve currency.
Powell is saying one thing and doing another. Haven’t we learned yet that you judge people by what they do and not by what they say? This guy is going to hand the Republicans the keys to every level of government.
No surprises in FOMC today. Curve inversion imminent. Fed under unrelenting pressure, Ukraine not a hall pass. No FOMC meeting in April. Is today’s 25bp all the inflation-fighting action they plan to deliver for the next two months? That might look like dereliction. The commodities pullback is likely to be offset by worsening supply chain disruption, surging services demand, and roaring shelter prices. I’m thinking an intra-meeting hike and/or 50 bp in May, and that if QT doesn’t include targeted sales, it will at least include targeted reinvestment and/or coordination with Treasury on issuance.
Yes. Come May it will be Since about 5 months since the fed acknowledged the “problem. In those intervening 5 months they will have delivered 25 basis points of hikes and a balance sheet that’s larger than it was when they removed transitory from their language.
0 credibility. Cancel the fed.
At this point, Powell has only been approved by the Senate Banking Committee- he has not been confirmed for his second term. I believe his words and his actions will tilt towards appeasing Biden/Congress until the confirmation process is finalized.
I was interested to see the comment section here almost as much as the article. What Powell said was entirely reasonable. They will raise rates to meet their dual mandate- and will be flexible. Inflation has persisted so they will continue to raise rates as necessary. Personally I doubt that they are going to have to raise rates 7 times. A look at the yield curve will tell you that the market is in agreement here despite many commentators critiques. The 2 year is now almost 2% and 10s are only about 20 bps higher. If the Fed goes 6 more times you will almost certainly have a whopper of an inversion. A look at the value of the dollar, or the recent price action in energy and some commodities are a clue that all that is not as it appears. When markets turn they turn fast. Performance of energy stocks is almost always a late cycle event. We have all gotten used to long economic cycles, but this time around my bet is that the cycle is going to come to an end a lot shorter than we have become accustomed to….(2023…)
Another thoughtful comment from RIA.
Central Banks, CB apologists and MMT folk pushing the boundaries of irrationality to a whole new level.
The current situation has been 15 years in the making. Consistent warning signs all over the economy and financial markets pointing towards the obvious, yet here we are.