– Powell Says 50 BP Hikes Will Be “On Table” Next Two FOMC Meetings
– 75 BP Hike Not Under Consideration
– Will Need to Be ‘Nimble’ Given Uncertain, Changing Outlook
– Quick-paced Balance Sheet Reduction To Begin June 1
By Steven K. Beckner
(MaceNews) – Federal Reserve policymakers not only continued raising short-term interest rates Wednesday, but picked up the pace with a 50 basis point rate hike, while also announcing it will soon start to reverse the bond buying it had done to hold down long-term rates.
But while the Fed’s policy making Federal Open Market Committee made clear there is more credit tightening to come, the future rate path remains in doubt amid tremendous uncertainty. While the Fed’s primary focus is confronting the worst inflation in 40 years, it also faces proliferating signs of economic cooling, global downside risks, and dramatically tightening financial conditions.
Chair Jerome Powell sounded more aggressive than the FOMC’s policy statement in comments to reporters. He indicated the FOMC is going to be moving the federal funds rate up at a fairly quick pace toward neutral and quite possibly beyond. Further 50 basis point rate hikes will be “on the table” at the next two FOMC meetings, he said, while 75 basis point rate moves are not under consideration.
However, Powell cautioned that the economic outlook could change, requiring the FOMC to be “nimble.” He sounded confident the Fed can avoid a recession but conceded that will be “challenging.”
The FOMC, which in mid-March left behind the zero lower bound after two years with a modest 25 basis point rate hike, voted unanimously to increase the funds rate target range from 25-50 basis points to 75-100 basis points and set the stage for an indefinite amount of further rate hikes.
Not since May 2000 has the FOMC raised the funds rate that much.
Ahead of the meeting, multiple Fed officials advocated pushing the funds rate to 2.5% or even higher by the end of this year, leading to market expectations of further aggressive rate actions. But the FOMC policy statement was nebulous following a meeting at which participants did not revise their funds rate projections. (In March the median projection for the end of this year was 1.9%.)
The FOMC simply reiterated that it “anticipates that ongoing increases in the target range will be appropriate.”
Powell was more specific and emphatic. In a prepared opening statement and in subsequent responses to questions, he signaled more 50 basis point rate hikes are likely ahead.
“We are on a path to move our policy rate expeditiously to more normal levels,” he declared. “Assuming that economic and financial conditions evolve in line with expectations, there is a broad sense on the committee that additional 50 basis point increases should be on the table at the next couple of meetings.”
“We will make our decisions meeting by meeting as we learn from incoming data and
evolving outlook for the economy,” he continued, adding, “We will continue to communicate our thinking as clearly as possible.”
Powell said “a 75 basis point increase is not something the committee is actively considering.”
The FOMC took its latest actions despite a 1.4% drop in first quarter GDP, among other signs of slowing. The Institute for Supply Management found deceleration of both manufacturing and non-manufacturing activity in April. Meanwhile, though, inflation has far exceeded the FOMC’s 2% target. The price index for personal consumption expenditures (PCE) rose 6.6% year over year in March, while the consumer price index rose 8.5%.
Powell said he and his colleagues are determined not to let high inflation get “entrenched.”
Explaining its decision, the FOMC pointed to upside and downside risks from the war in Ukraine and China’s Covid lockdown, but put more emphasis on inflation: “The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain. The invasion and related events are creating additional upward pressure on inflation and are likely to weigh on economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions.”
“The Committee is highly attentive to inflation risks,” the statement added.
If the FOMC raises the funds rate another 50 basis points at its June 14-15 meeting, as Powell suggested it may well do, it will have moved halfway toward the FOMC’s estimated 2.4% “neutral” or “longer run” rate.
Powell suggested “neutral” is a moving target that lies somewhere in a “2% to 3%” range, but vowed the FOMC will get to “neutral” “expeditiously.” Indeed, he said the FOMC is prepared to take rates above neutral into restrictive territory.
“What we are doing really is we are raising rates expeditiously to what we see as the
broad range of plausible levels of neutral, but we know that there is not a bright line drawn on
the road that tells us when we get there. We are going to be looking at financial conditions,” he said.
“Our policy affects financial conditions and financial conditions affect the economy,” he continued. “We are going to look at the effect of our policy moves on financial conditions, are they tightening appropriately.”
“We are going to be looking at the effects on the economy,” he went on. “We are going to be making a judgment about whether we have done enough to get us on a path to restore price stability…”
‘So, if that path happens to involve levels that are higher than estimates of neutral, we will
not hesitate to go to those levels,” he added. “We won’t.”
Powell cautioned “there is a false precision in the discussion that we as policymakers don’t really feel. It’s you are going to raise rates and going to be inquiring how that is affecting the economy through financial conditions, and of course if higher rates are required, then we won’t hesitate to deliver them.”
Powell has said on a number of occasions he thinks the Fed can achieve a “soft landing” and avoid a recession, but he made no guarantees when asked again whether the Fed can get inflation back down to 2% without causing a recession. And he said lowering inflation is crucial to longer run prosperity.
Thanks to a strong economy and an “extremely tight labor market,” he reiterated his belief that the United States is “in a good position” to withstand monetary tightening.
“I think we have a good chance to restore price stability without a recession, without a severe downturn and without materially higher unemployment,” he said.
“Typically in a recession you would have unemployment,’ he explained. “Now you have surplus demand. There should be room in principle to reduce that surplus demand without putting people out of work.”
But Powell warned, “we don’t have precision surgical tools, we have essentially interest
rates, the balance sheet and forward guidance. They are famously blunt tools. They are not
capable of surgical precision ….”
Even so, Powell added “there is certainly a plausible path to this (soft landing).”
While emphasizing the FOMC’s commitment to “restoring price stability,” Powell acknowledged downside risks that could require a different policy course, noting that the situations in Ukraine and China could further damage supply chains.
“Making appropriate monetary policy in this uncertain environment requires a recognition that
the economy often evolves in unexpected ways, inflation has obviously surprised the upside
over the past year, and further surprises could be in store,” he said. “We therefore will need to be nimble in responding to incoming data and the evolving outlook.”
Powell promised “we will strive to avoid adding uncertainty to what is already a extraordinarily challenging and uncertain time.”
The FOMC also set the stage for “quantitative tightening.” After halting asset purchases in early March, the FOMC announced that it will begin shrinking its $9 trillion balance sheet by allowing a steadily increasing quantity of maturing securities to run off instead of reinvesting or rolling over proceeds.
As revealed in minutes of its March meeting, the FOMC announced it will initially cap runoffs at $30 billion per month for Treasury securities and increase the cap to $60 billion per month
after three months. For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month and after three months will increase to $35 billion per month.
Powell expressed hope that balance sheet reduction will amplify the impact of rate hikes on financial conditions as the Fed tries to “restore balance between supply and demand” and lower inflation. But he declined to quantify the effect of slashing Fed bond holdings.
“I would stress how uncertain the effect is of shrinking the balance sheet,” he said. “We run these models and everyone does in this field, and make estimates of what will be, how do you measure a certain quantum of balance sheet shrinkage compared to quantitative easing. These are very uncertain …,” he said.
Powell pointed to estimates balance sheet reduction is equivalent to “sort of one quarter percent, one rate increase over the course of a year at this pace.” But he said there are “very wide uncertainty bands” and noted some have estimated a smaller effect.
Nevertheless, balance sheet reduction will be “part of returning to more normal and more neutral financial conditions, and our strategy is to set up a plan, have it operate and have the interest rate be the active tool of monetary policy,” he said.
Powell indicated he is pleased with how financial markets have reacted to the actions the Fed has already taken and to its “forward guidance” on further monetary tightening. He said it proves the Fed still has “credibility.”
“In the fourth quarter of last year as we started talking about tapering sooner and then raising rates this year, you saw financial markets reacting very appropriately, not to bless any particular day’s measure, but the way financial markets, the forward rate curve has tightened in response to our guidance and our actions really amplifies our policy,” he said.
“Monetary policy is working through expectations now to a very large extent, we have only done two rate increases,” he elaborated. “But if you look at financial conditions, the two-year (Treasury note yield) is at 280 now, (whereas) in September I think it was 20 basis points. And
that’s all through the economy; people are feeling those higher rates already.”
Powell said “that shows that the markets think that our forward guidance is credible….(W)e want to keep it that way.”
In raising the funds rate 50 basis points, the FOMC lifted the rate paid on reserve balances the same amount to 0.9%. Similarly, the offering rate on overnight reverse repurchase agreements was raised to 0.8%. The Board of Governors, the core of the FOMC, raised the primary credit or “discount” rate 50 basis points to 1.0%.