– Powell Says FOMC May Move Faster If Needed To Reduce Inflation
– Says Funds Rate Could Go ‘Beyond’ Downwardly Revised ‘Neutral’ Rate
– Balance Sheet Reduction Plan Could Be Announced As Soon As May Meeting
By Steven K. Beckner
(MaceNews) – After holding short-term interest rates near zero for two years to support a Covid-riven economy, the Federal Reserve’ finally raised them a quarter percentage point Wednesday, despite heightened concerns about Russia’s invasion of Ukraine.
What’s more, the Fed’s rate-setting Federal Open Market Committee served notice it plans on raising short-term rates considerably further. It also said it will likely start reversing the heavy bond buying it has done to lower long-term rates before long.
Chair Jerome Powell said he and his FOMC colleagues are determined to “restore price stability” as a prerequisite for sustaining recovery and vowed to raise rates faster than now planned, possibly higher than “neutral” if necessary.
The 25-basis point increase in the federal funds rate to a target range of 25 to 50 basis points, which Powell had previously said he intended to seek, is sure to be just the first in a series of rate hikes as the FOMC strives to normalize monetary policy.
In its policy statement, the FOMC said it “anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting.”
In their revised Summary of Economic Projections, 16 FOMC participants projected the funds rate will go to a median 1.9% by the end of this year, implying six additional 25 basis point rate hikes or some combination of 25 and 50 basis point hikes.
St. Louis Federal Reserve Bank President dissented against the FOMC decision because he wanted an immediate 50 basis point move.
By contrast, in the December SEP, FOMC participants had projected just three 2022 rate hikes.
Fed governors and presidents projected the funds rate will rise to 2.8% by the end of next year, up from the 1.6% projected in December. That would be 40 points higher than the FOMC’s downwardly revised estimate of the “neutral” rate.
Corresponding to the steeper funds rate trajectory, Fed governors and presidents revised up their inflation forecast in wake of a series of jumps in various inflation indices. (The consumer price index was up 7.9% compared to a year ago in February – worst since 1982, when Paul Volcker’s Fed was trying to vanquish double-digit inflation.)
Officials forecast inflation, as measured by the price index for personal consumption expenditures, will moderate to 4.3 on a fourth quarter-over-fourth quarter basis, by the end of 2022, but that is far less optimistic than the December SEP, when the PCE was projected at 2.6%. In the fourth quarter of 2023, the PCE rate is projected to be running at 2.7%, compared to December’s 2.3%.
The FOMC participants projected the unemployment rate will be 3.5% in the fourth quarter of this year and in the fourth quarter of next year. They forecast real GDP growth of 2.8% this year, down from 4.0% in December, but still well above the economy’s 1.8% “longer run” potential growth rate, as Powell pointed out.
The FOMC made the credit tightening decision despite recognizing the potential economic damage of Russia’s invasion of Ukraine. “The implications for the U.S. 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.”
In somewhat of a surprise, officials lowered their estimate of the “longer run” funds rate — usually thought of as a proxy for “neutral” — from 2.5% to 2.4%. That’s significant since Powell and others have spoken of wanting to get back to a “normal” or “neutral” range of 2-2 1/2 by the end of next year. The projected 2.8% funds rate for the end of 2023 implies a move into restrictive territory for monetary policy.
As the FOMC raised the funds rate 25 basis points, it raised the interest rate on excess reserves (IOER) a like amount to 0.40%. The FOMC also lifted the offering rate for overnight reverse repurchase agreements to 0.30%.
And the Board of Governors, the core of the FOMC, voted to raise the primary credit rate for discount window loans 25 basis points to 0.50%.
The FOMC halted purchases of Treasury and agency mortgage-backed securities, but for the time being refrained from reducing bond holdings, directing the New York Federal Reserve Bank’s open market trading desk to roll over at auction all principal payments from the Fed’s holdings of Treasury securities and to reinvest all principal payments from MBS holdings.
However, Powell told reporters the FOMC had “made excellent progress on agreeing on the parameters” for shrinking the balance sheet and said an announcement of the final plan “could come as soon as our next meeting in May.” He said the plan will “look familiar,” i.e., similar to the series of rising caps on balance sheet run-off implemented during the balance sheet reduction done in 2017.
Powell said the balance sheet shrinkage the FOMC is likely to approve for this year could equal “another rate hike” on top of the seven already built into the SEP “dot plot.”
Powell was adamant about the need to start raising rates, although he denied the FOMC had failed to act soon enough, based on what it knew at the time. He said inflation had risen more than expected due to more persistent supply chain problems and other unforeseen factors and repeatedly vowed to “use our tools” to lower inflation.
He said the “very strong economy” and “extremely tight labor market” should be able to “withstand tighter monetary policy” and even “flourish” as the Fed raises rates and as financial conditions tighten in response.
Powell acknowledged that the ongoing Ukraine war could alter the Fed’s policy plans.
“(T)he implications of Russia’s invasion of Ukraine for the U.S. economy are highly uncertain,” he said. “In addition to the direct effects from higher global oil and commodity prices, the invasion and related events may restrain economic activity abroad, and further disrupt supply chains, which would create spillovers to the U.S. economy through trade and other channels.”
“The volatility in the financial markets could tighten credit conditions and affect the real economy,” he added.
“Making appropriate monetary policy in this environment requires a recognition that the economy often evolves in unexpected ways,” Powell went on. “We will need to be nimble in responding to incoming data and the evolving outlook and we’ll strive to avoid adding uncertainty to what is already an extraordinarily challenging and uncertain moment.”
Nevertheless, Powell reiterated that “the committee is determined to take the measures necessary to restore price stability. The American economy is very strong, and well-positioned to handle tighter monetary policy.”
“We’re not going to let high inflation become entrenched,” he declared. “The costs of that would be too high. And we’re not going to wait so long that we have to do that.”
Powell seemed particularly concerned that wages are rising “faster than is consistent” with 2% inflation, although he said he does not yet see a “wage-price spiral.”
Although the FOMC is already projecting more than twice as many rate hikes as it it did just a few weeks earlier, Powell said policymakers are prepared to be even more aggressive.
“Each meeting is a live meeting and if we conclude it will be appropriate to raise interest rates more quickly, then we’ll do so,” he said.
The Fed chief also sent a strong signal the FOMC is prepared not just to remove accommodation but to raise the funds rate above a “neutral” level.
“No one wants to have to really put restrictive monetary policy on in order to get inflation back down,” he said. “So frankly, the need is one of getting back up, getting rates back up to more neutral levels as quickly as we practicably can.”
However, he said the FOMC is prepared for “moving beyond that if that turns out to be appropriate.” He noted that some Fed officials had already marked down rates above the neutral rate.
Asked about the pacing of rate hikes, Powell noted that he and his colleagues had projected seven rate hikes for 2022, and that there are six remaining FOMC meetings. What’s more, he added, “there’s also the shrinkage of the balance sheet which people do the math different ways. But that might be the equivalent of another rate increase just from the runoff of the balance sheet.”
Powell said that over the next two years “many people in their forecasts are having tight policy from a real interest rate standpoint.”
He conceded, “it’s a highly uncertain environment, and we don’t know what’s going to happen.”
But again, he said, “we know we’re going to deploy our tools to achieve our goals and that includes the price stability goal.”