Federal Reserve Chairman Jay Powell essentially promised a quarter point increase in short-term interest rates at the conclusion of the March 16, 2022 Federal Open Market Committee (FOMC) meeting when he testified on Capitol Hill March 2 and 3. That seems like an eternity in today’s rapidly changing environment. (We went from aging in COVID years to aging in Putin years.)
Since then, much of the world has united effective and punitive sanctions on Russia, including sanctions on Russia's central bank and substantial curbs to Russian oil imports. The timing couldn’t be worse for the Federal Reserve, which is already chasing inflation for the first time since the 1980s. The disruptions we are seeing are adding fuel to a well kindled inflation fire that goes well beyond the energy sector and could touch much more of our daily lives. Inflation expectations, which increase the risk that inflation will distort behaviors and become more entrenched, have already picked up.
The economy is more resilient than it was a year ago, with a tailwind of robust employment and wage gains, along with funds saved during the pandemic and in response to stimulus checks. Even the bottom quartile of households entered the year with more savings than prior to the crisis.
That is both a blessing and a curse. A blessing in that we can better weather the storm of the surge in prices without triggering a fully fledged recession; a curse in that it ups the risk of a hotter and more prolonged period of inflation, which will not easily be rectified.
In response, the Fed is expected to be demonstrably more hawkish than it was just a few months ago. The statement following the FOMC meeting is expected to highlight the need for a series of rate hikes, while closely monitoring financial market conditions.
Chairman Jay Powell will be walking a tightrope, balancing the needs to raise rates and rein in a more systemic rise in inflation with the need to avert a meltdown in credit markets. The collapse of the economy in 2008-09 proved that financial crises are much harder to recover from than a Fed-induced slowdown.
The March meeting will provide an update to participants’ forecasts. Look for overall economic growth to be marked down and inflation up. The number of rate hikes that participants expect in 2022 will rise from three to five.
There will be outliers who pencil in more than five rate hikes for the year. We are still forecasting seven rate hikes. President James Bullard of the St. Louis Fed, who is voting this year, and his colleague Governor Chris Waller, are among the most aggressive in their push for rate hikes.
Powell was careful not to rule out a half percent move in rates at a subsequent meeting. That could come as soon as May. We expect the Fed to announce a reduction in its bloated balance sheet during the June FOMC meeting. The Fed has never raised rates and reduced the size of the balance sheet so close together. There is a lot of uncertainty surrounding the outcomes of simultaneous moves. The path ahead is littered with land mines.
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