– Powell Signals Rate Hikes in July and Beyond; 50 Most Likely In July
– Dot Plot Projects Elevated Funds Rate Amid Worse Inflation, Slower GDP, More Jobless
– Officials See Funds Rate at 3.4% End 2022; 3.8% End 2023; 3.4% End 2024
– ‘Neutral’ Rate Revised Up, But Only by A Tenth
By Steven K. Beckner
(MaceNews) – Federal Reserve policy-makers turned more aggressive in their monetary tightening campaign Wednesday amid mounting concern about inflation, raising short-term interest rates by 75 basis points and anticipating further relatively aggressive rate hikes in coming months.
It was the first time the Fed raised the federal funds rate by 75 basis points since 1994, when Alan Greenspan was chairman. The lone dissent was from Kansas City Federal Reserve Bank President Esther George, who preferred a 50 basis point move.
The Fed’s policy-making Federal Open Market Committee signaled further monetary tightening by repeating its expectation that “ongoing increases in the target range will be appropriate.”
Chair Jerome Powell made clear rates will continue to rise this year to reach a “moderately restrictive” stance, but suggested the FOMC is more likely to raise the funds rate by 50 basis points than by 75 basis points at its July 26-27 meeting.
Underscoring the FOMC’s determination to cool demand pressure on prices and wages, participants substantially increased their rate projections for the next few years.
Further emphasizing their determination to bring down an inflation rate which is running more than triple the Fed’s target, the FOMC added a new declaration to its policy statement: “The Committee is strongly committed to returning inflation to its 2 percent objective.”
Conspicuously absent from the latest statement was the previous assertion that “with appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.” Powell explained that he and his colleagues no longer felt comfortable saying that, given that inflation is partially governed by supply factors outside the Fed’s control.
For the third time since it left the zero lower bound in mid-March, the FOMC raised the funds rate by 75 basis points to a target range of 1.5% to 1.75%.
The FOMC also reaffirmed its policy of reversing the bond buying it had done to hold down long-term rates. Under its previously announced plan, the Fed is allowing a monthly run-off of maturing securities of $47.5 billion. The allowed run-offs are scheduled to rise to $95 billion per month in September.
For the first time, newly confirmed members of the Fed Board of Governors Lisa Cook and Phillip Jefferson participated and voted with the FOMC majority.
Not only did the FOMC raise rates immediately, FOMC participants significantly elevated their funds rate expectations in the revised Summary of Economic Projections. They now project the funds rate will end this year at 3.4%, up from 1.9% in the March SEP. By the end of next year, Fed officials now see the funds rate rising to 3.8%, up from 2.8% in March, before receding to 3.4% by the end of 2024..
The estimated “longer run” or “neutral funds rate was revised higher, but only slightly from 2.4% to 2.5%, where it was before being revised down in March.
Accompanying the anticipated faster pace of rate hikes was a gloomier set of economic forecasts. Officials now see GDP growth slowing to 1.7% this year and next, while the unemployment rate is projected to rise to 3.7% at the end 2022; to 3.9% at the end of 2023 and to 4.1% at the end of 2024. By contrast, in March, officials projected GDP growth of 2.8% this year and 2.2% next year. They foresaw unemployment staying at 3.5% this year and next.
FOMC participants also revised their inflation projections up considerably in wake of larger than expected consumer price increases. They now project PCE inflation of 5.2% this year (4.3% core); 2.6% next year (2.7% core) and 2.2% in 2024 (2.3% core). By contrast, in March, officials forecast PCE inflation would decline from 4.3% this year (4.1% core) to 2.7% next year (2.6% core) and to 2.3% in 2024 (2.1% core).
The new projections suggest less optimism that the Fed will be able to achieve a so-called “soft landing” and a greater willingness to accept slower growth and higher unemployment to get inflation under control.
Powell said the FOMC”s objective is still to get inflation down while sustaining a “strong labor market,” but conceded achieving a “soft landing” has become more difficult because of “many factors we don’t control,” notably the war in Ukraine – a point he made repeatedly.
“There is a path for us to get there,” he said, but “it’s not getting easier; it’s getting more challenging.”
If the Fed can get inflation down closer to 2% while unemployment rises to 4.1%, as officials are projecting, “that would qualify as meeting that (soft landing) test,” Powell said, adding that 4.1% would still be a low unemployment rate.
“We’re not trying to induce a recession now,” the Fed chief emphasized, adding that the FOMC is aiming at “2% inflation consistent with a strong labor market. He stressed that the Fed must restore price stability to ensure longer run health of the economy.
The FOMC raised rates aggressively despite a 1.4% drop in first quarter GDP, among other signs of slowing, as Powell and his colleagues focused more heavily on inflation.
The FOMC’s action comes in wake of more troubling inflation reports that sparked very adverse reactions on Wall Street. Since the Labor Department reported an 8.6% year-over-year May increase in the consumer price index, the major stock gauges have plummeted, leaving the S&P 500 in bear market territory. An even bigger increase in the May producer price index and increased inflation expectations reinforced the discouraged mood on Wall Street. Other asset values have also declined steeply.
Bond yields have also soared, with the 10-year Treasury note yield climbing to 3.3890% ahead of the FOMC announcement – a level last seen 11 years ago.
Explaining why the FOMC raised rates by 75 basis points, instead of the 50 basis points he had strongly indicated following the May meeting, Powell cited the surprisingly large 8.6% year-over-year rise in the May consumer price index reported last Friday, coupled with reports of rising inflation expectations.
Recalling that he had pledged to be “nimble” in combating inflation, Powell said that when “inflation again surprised to the upside” and inflation expectations deteriorated, “we decided a larger increase was warranted” to “continue the process of moving expeditiously to more normal levels…”
After the disappointing inflation news, Powell said he and his colleagues asked themselves, “what is the appropriate thing to do? Do we wait?”
Powell said all but one of the FOMC members decided, “that’s not where we are with this. So, we decided to go ahead” with a larger rate hike.
“75 basis points seemed like the right thing to do at this meeting, and that’s what we did,” he added.
But Powell cautioned financial markets against expecting further 75 basis point rate hikes at upcoming meetings. “I do not expect moves of this size to be common; 50 basis points seems most likely at our next meeting.”
At the same time, as he has in the past, Powell told reporters the economic outlook is “highly uncertain,” requiring the FOMC to be “flexible.”
At the July meeting, Powell said it “could will be a decision between 50 and 75” to “put us in a more normal range.”
He said the consensus of the FOMC is that “we would like to be in modestly restrictive territory” of 3-5%. “That’s what people want to see … as the appropriate path for getting inflation under control.”
In mid-May Powell had said he wanted to see “clear and convincing evidence” that inflation is moderating. Asked about what he meant, he replied, “what we want to see is a series of declining monthly readings on inflation. We’d like to see inflation headed down.”
“Right now our policy rate is well below neutral,” he continued. “Soon enough we will have the policy rate … up to where we think it should be.”
“Then the question is ‘do you slow down? Is it appropriate to slow down from 50 to 25 or speed up?’” he went on. “That’s the kind of thinking we’ll do ….”
But, he added, “we’re not going to declare victory until we see compelling evidence.”
Despite proliferating signs of economic slowing, including a surprisingly weak May retail sales report delivered Wednesday morning, Powell reiterated his belief that “the U.S. economy is in a strong position (and) is well positioned to deal with higher interest rates.”
Powell conceded there is “always a risk of overdoing it” with rate hikes, but said “the worst mistake we could make would be to fail … to restore price stability.”
Powell and others have been saying continuously they want to “expeditiously” lift the funds rate to “neutral” and, if necessary beyond. But as inflation has soared, questions have arisen about just where neutral is. FOMC participants’ median estimate of the “longer run” funds rate, considered a proxy for the neutral rate, was estimated at 2.5% in the latest SEP, but some would argue that is far too low.
The “longer run” or neutral funds rate is a nominal rate that includes an assumption about the hypothetical real equilibrium short-term interest rate, which Fed officials have generally estimated at no more than half a percentage point, plus the Fed’s longer run 2% inflation target.
But obviously inflation is not 2%, and may not fall to that rate for quite some time. Meanwhile, with inflation running at 6.3% (using the PCE measure), the real funds rate remains deeply negative, leading some to contend the Fed needs to set its sights on a higher “neutral” rate that factors in higher inflation.
Powell all but promised the FOMC will go beyond the putative “neutral” rate into “restrictive” territory, which would have the same effect as revising up the neutral rate, but some suspect that the funds rate may need to go well beyond the ranges now projected to bring inflation under control.
In raising the funds rate 75 basis points, the FOMC lifted the rate paid on reserve balances the same amount to 1.65%. Similarly, the offering rate on overnight reverse repurchase agreements was raised to 1.75%. The Board of Governors, the core of the FOMC, raised the primary credit or “discount” rate 75 basis points to 1.75%.