Powell hints at more aggressive rate hikes by the Fed

On Monday 21st March, the US markets saw bond yields hardening to 2.34%, dollar index touching 98.5 levels and the Dow Jones index crashing. The common factor among all these developments was the sharply hawkish statements made by Jerome Powell.

He made these hawkish comments whilst addressing the 38th Annual Economic Policy Conference of the National Association for Business Economics on the topic of Fed Policy Options.

It may be recollected that in the FOMC statement issued by Jerome Powell last week, he had already hiked rates by 25 bps and guided for another 6 rate hikes across the next 6 meetings of the FOMC in the year 2022.

The target is for the Fed rates to be between 2% and 2.25% by end of 2022. However, the latest speech by Powell betrays a sense of urgency and hawkishness indicating that the Fed could move much faster than originally designed.


Check - FED Hints at Rate Hikes

5 key points made by Jerome Powell

The speech of Jerome Powell made some interesting points on rising hawkishness of the Fed and its members. 

1) Powell underlined in the speech that the Fed had the dual mandate of promoting maximum employment and stable prices. However, as labour markets were fairly strong, inflation had become their primary focus. Powell underlined in speech that high inflation hit those segments of society least prepared to withstand the burden, making it unjust. 

2) While the Fed statement spoke of 1 rate hike in each of the remaining 6 policies, the speech indicates that Powell would be open for more aggressive hikes in certain months.

The idea would be to first return monetary policy to neutral level and then also take it tighter restrictive levels, if required. Fed plans to start trimming the balance sheet from May, but Powell refused to commit any timelines.

3) An interesting point came out in Powell’s speech. Labour markets in the US were, simultaneously strong and tight. Unemployment is comfortable at just 3.8% but more job openings are going unfilled with 1.7 job postings for every person looking for work.
 

This indicates tight labour markets. This could be due to a combination of labour market fatigue and also because, people can afford to wait for better job opportunities.
 
4) Powell reiterated in his speech that while inflation was supply driven, it was a lot stickier than imagined. That was largely due to a combination of severe supply side constraints combined with robust demand for durable goods.

The ongoing war between Russia and Ukraine again threatened global inflation via the oil price route. So, inflation focus it would be; through and through.

5) Powell has also given a warning that the pandemic had destroyed a lot of macro assumptions. Hence it was entirely possible that the Fed may have to go to the extent of resisting inflation forcibly, which could be painful.

The normal cycle of supply normalizing and demand cooling had not happened for a long time. That had raised the urgency of strong monetary responses.

How is the Fed action plan going to be?
 

The Powell speech also gave some indications of the action plan of the Fed. At a basic level, the Fed has pencilled in 6 rate hikes across the remaining 6 FOMC meetings in 2022. However, Powell underlined that achieving 2% inflation would not be easy.

He has warned that only by combining rate hikes with gradual unwinding of the $9 trillion balance sheet; Fed can achieve the target of 2% inflation over next 3 years.

Powell, in his speech, touched upon the very delicate question of whether the monetary policy action can lower inflation without causing an economic recession.

Powell believes that some moderation would happen as base effect vanished but higher interest rates have rarely caused recessions. However, to quote Powell, “The risk is that Monetary policy is a blunt instrument, incapable of surgical precision”. That is the sum and substance.

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