- With ongoing inflationary pressures and a continued decline in the unemployment rate, the Fed appears ready to pick up the pace of normalizing monetary policy.
- The Fed confirmed that at this point they plan to raise the fed funds rate at the March meeting but reiterated that the pace and frequency of rate hikes will be data-dependent.
- The move toward tighter monetary policy coupled with not so “transitory” inflation has produced large bouts of volatility across global equity markets.
At the January 26th meeting, the Federal Reserve and its monetary policymaking body, the Federal Open Market Committee, did not make any formal changes to its policy but they did have quite a bit to say about the path forward. First off, Fed officials decided to hold the target range for their benchmark policy rate unchanged at zero to 0.25% as expected but noted that the time for a hike may be soon. Fed Chair Jerome Powell, when citing a strong job market and inflation well above its 2% target, stated “it will soon be appropriate to raise the target range for the federal funds rate.” ¹ He went on to say the committee is eyeing the March meeting for liftoff if the conditions are there to do so.
The sudden hawkish tone from the Fed reflects ongoing inflationary pressures and a job market that has recovered much quicker than expected since the onset of the pandemic. Fed officials’ willingness to raise rates potentially 4-5 times this year or more while simultaneously wrapping up its asset purchases have critics questioning if they are behind the curve in tackling inflation. Former New York Fed Bank President William Dudley has been saying for months that the Fed’s current structure and stance on providing forward guidance on interest rates nearly ensures they will be too slow to react and will be forced to play catch-up.
The Fed’s timing on tightening monetary policy is certainly up for debate and will likely only be judged accurately in hindsight, but what we do know is this time is different. During the most recent rate hike cycle that ran from December 2015 through 2018, the Fed was dealing with tepid economic growth and little to no inflation, meaning they had to approach raising rates with kid-gloves as to not tank the economy.
During Chair Powell’s press conference last week, he mentioned several times that the economy can withstand more increases than the previous rate hike cycle. “The economy is quite different,” Powell said. “It’s stronger, inflation is higher, the labor market is much stronger. I think there’s quite a bit of room to raise interest rates without threatening the labor market.” ¹ Based on the current strength of the economy and with inflation remaining a threat, Powell is suggesting that the Fed could move sooner and faster than in previous rate hiking cycles and that policy decisions may be different as well.
This meeting cleared up a couple of things regarding the normalization of monetary policy. First, the initial rate hike will likely come at the next FOMC meeting in March, and it will most likely be a quarter-point increase with a slight chance (20%) of a half-point bump. Second, the balance sheet runoff process will likely commence shortly thereafter.
We have talked for years about how the Fed has a very difficult job of balancing the tradeoff between inflation and employment, and particularly how to deal with sub-target inflation. Fast forward to today and the Fed is facing the opposite challenge of bringing inflation lower without inducing a recession. The goal here is to raise interest rates just enough to cool off the economy, bringing inflation down without completely interrupting the momentum in labor markets. We’ve been hearing for years that the Fed has the tools to effectively lower inflation without wrecking the economy, the next 12-24 months will likely fully test their abilities.
¹Powell, Jerome; Transcript of Chair Powell’s Press Conference; January 26, 2022; www.federalreserve.gov