As expected, the Federal Reserve raised its target interest rate by 25 basis points last Wednesday, as Fed Chair Jerome Powell said two weeks ago that it would do. What was surprising was that the Fed also telegraphed that it plans to raise rates six more times this year, to at least 1.75% by the end of this year, and four times next year, with fed funds ending at around 2.75% by the end of 2023.
That was a lot more aggressive than some observers, including this one, had expected. Yet the market seemed happy with it. After a brief initial sell-off, stocks soon resumed their upward path, apparently because they liked the certainty it provided, at least for now, as well as the gradual nature of the Fed’s schedule.
But how certain can we be? Will the Fed really carry through with this, or will it revert to its easy-money ways? And even if it does do what it says it plans to do, will it be enough to get inflation under control while at the same time avoiding pushing the economy into recession?
We’ll have to wait and see.
Clearly, raising interest rates is the right thing to do and is long overdue. It’s clear that the Fed did not want to take these steps unless it really believed that inflation was not a “transitory” problem, a fantasy it finally gave up on at the end of last year, although it took months for it to come to that conclusion after just about everyone else did. It should have been crystal clear to the learned army of economists at the Fed that pumping trillions of dollars into the economy, both on the fiscal as well as the monetary side, while keeping its benchmark interest rate at near-zero even as the economy prospered would eventually lead to inflation. It’s now finally ending the emergency measures meant to deal with the financial fallout from the pandemic measures that went way beyond the actual damage that sent inflation to its highest levels since the 1980s.
The most ironic part of the Fed’s interest rate vote was that the lone dissenter to the 25-basis point hike was St. Louis Fed President James Bullard, who previously had been one of the most dovish members, especially in the aftermath of the 2008 crisis. He wanted a 50-basis point hike. The rest of the FOMC voters preferred to start off slow.
The Fed also put off dealing with the $9 trillion elephant in the room, namely its balance sheet. While the Fed has finally stopped buying new Treasury bonds and mortgage-backed securities, it elected to kick down the road when it would start paring that portfolio, saying that it will address that issue “at a coming meeting.” The Fed doesn’t meet again until early May. In the meantime, the balance sheet will continue to grow as coupon payments and maturing bonds are reinvested in more bonds, which will keep a lid on long-term rates, not exactly an anti-inflationary tactic.
Whether this go-slow approach is the right one is certainly a good question but one that won’t be answered for several months, in which time inflation may continue to get worse. Unlike previous Fed chairs, Powell has made it clear he doesn’t like to surprise the financial markets with any monetary policy changes between meetings, so the Fed has pretty much locked itself into basically not doing anything else for the next six weeks. Is a quarter-point interest rate rise and no reduction in the balance sheet really going to have any measurable effect on inflation in the near term? It’s hard to imagine.
In its defense, the Fed’s hesitancy can probably be understood somewhat by its not wanting to drive the economy into recession, although that seems like a remote possibility given these baby-step measures.
But the main reason for my skepticism is that it’s hard to believe that a Fed that has been so used to easy-money policies for the past 14 years or so can suddenly turn itself into an inflation-fighting machine. By constantly referring to its vaunted “tools,” the Fed seems to think it can turn inflation on and off at will without causing too much disruption. Many investors seem to believe it, as evidenced by the post-meeting stock market rally, or at least they want to.
But it will take some real evidence to convince the skeptics. Jay Powell is not Paul Volcker. But maybe he doesn’t have to be. He doesn’t have double-digit inflation to deal with, at least not yet. Maybe the Fed really can pull this off.
I guess we’ll just have to wait and see and hope for the best. In the meantime, the stock market party lives on, supported by the Fed.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.