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The Federal Reserve is widely expected to get tough on inflation at its May meeting on Wednesday, after consumer prices surged for more than a year and the central bank was accused of dragging its feet.
In a 2pm announcement that is the most anticipated monetary policy announcement in years, the Fed is expected to raise benchmark interest rates by half of a percentage point, taking the target rate to 1 percent.
The central bank is also expected say it will begin the process of reducing its $9 trillion balance sheet, which ballooned during the pandemic as the Fed gobbled up bonds to pump money into the economy.
A 0.5 percent rate hike would be the biggest single rate increase since May 2020, but the increase and balance sheet tightening have been widely telegraphed by Fed policymakers and are already priced into markets.
On the other hand, markets will be watching Fed Chair Jerome Powell’s 2.30pm press conference, and could react swiftly to any signals that the rate hike path will accelerate this year.
Markets will be watching Fed Chair Jerome Powell’s 2.30pm press conference, and could react swiftly to any signals that the rate hike path will accelerate this year
The consumer price index increased 8.5% in March from a year ago, a 41-year high
‘A 50 basis point hike will be seen as the bare minimum – we think that it is a nailed-on certainty,’ said Matthew Ryan, Senior Market Analyst at Ebury.
‘Powell’s communications on additional rate increases, and the bank’s latest view on the inflation overshoot will, however, be closely watched,’ he added. ‘We expect Powell to keep the door open to an aggressive pace of hikes during the remainder of the year.’
While higher interest rates could help curb rising inflation, they will also increase the cost of borrowing for many Americans, affecting everything from mortgage rates to credit card interest.
Powell and other members of the Federal Reserve Open Markets committee have been under pressure for more than a year to tackle soaring inflation, which Powell long dismissed as ‘transitory’.
The consumer price index increased 8.5 percent in March from a year ago, a 41-year high, and soaring prices for essentials such as food and gasoline have battered American households.
The Fed has a dual mandate to maintain ‘full employment’ and keep inflation steady at 2 percent annually. Higher interest rates usually tame inflation, but can put a damper on hiring.
The Federal funds effective rate is seen since 1955. The rate remained near zero through the pandemic until a 0.25% hike at the central bank’s March meeting
The Fed’s balance sheet exploded to $9 trillion during the pandemic as the bank gobbled up Treasury bonds and mortgage-backed securities to pump cash into the economy
The ‘dot plot’ released in March shows the expectations of FOMC members on future target levels for the federal funds rate. The next dot plot will not be released until June
Throughout the pandemic, the Fed seemed to place a much greater emphasis on employment than inflation, keeping interest rates near zero and pumping trillions into the economy through bond purchases.
Though the economy shrank unexpectedly in the first quarter of this year, unemployment is near the 50-year low reached just prior to the pandemic.
New data on Tuesday showed that there are nearly double the number of job openings as there are unemployed people. Job openings hit a record 11.5 million in March.
Inflation, on the other hand, has emerged as a top concern for American families and small businesses.
The issue is one of major threats to Congressional Democrats in the fall midterms, polls show. The Fed is supposed to be politically neutral, though the chair and board are nominated by the president.
Powell was first nominated by former President Donald Trump, and was re-nominated by President Joe Biden, though his second nomination is still pending in the full Senate.
The U.S. economy shrank last quarter for the first time since the pandemic recession
At Wednesday’s meeting, the Fed is expected to raise its short-term target policy rate to a range between 0.75 percent and 1 percent, and set in motion a plan to trim its massive portfolio of Treasuries and mortgage-backed securities by as much $95 billion a month.
Markets have priced in further rate increases through this year and into next, including at least a couple more half-percentage-point hikes.
Traders are betting the central bank moves much more quickly than it had anticipated it would in March to raise borrowing costs and curb inflation.
With no fresh Fed economic or policy rate projections due until the central bank’s June meeting, most clues on how far and how fast it is prepared to go will come from Powell’s news conference
The Fed began its current round of policy tightening in mid-March with a quarter-percentage-point rate hike, smaller than many policymakers had wanted given inflation had hit a 40-year high, but calibrated so as not to inject more uncertainty into global markets roiled by Russia’s February 24 invasion of Ukraine.
In the weeks since that decision, inflation has gained new steam as the war pushed up oil and food prices and China’s strict lockdowns to combat the spread of COVID-19 further disrupted supply chains.
Data on the U.S. labor market also suggests increasing labor market tightness, with employment costs surging as businesses struggle to hold onto workers. A record number of job openings may also translate to higher wages that could also feed through to inflation.
All that is ratcheting up the pressure on the Fed to act more decisively to rein things in.
‘Powell will continue to have a strong incentive to sound hawkish,’ Piper Sandler economist Roberto Perli said this week. ‘The Fed’s focus these days is 100 percent on bringing inflation down, and hawkish expectations help that cause.’
With opportunities abundant, the number of people quitting their jobs rose to 4.5 million in March, the most resignations in a month since records began in 2000
In the run-up to this week’s meeting, Powell has said he wants to get rates ‘expeditiously’ to what Fed policymakers regard as a ‘neutral’ range of 2.25-2.5 percent, and then higher if needed.
Most of his colleagues appear to be on board with at least the first part of that plan.
The aim would be to lift borrowing costs high enough and fast enough that households slow spending and businesses pare hiring in response, reducing inflation that is now about three times the Fed’s 2 percent target.
But the central bank wants to avoid raising rates so high or so fast that it short-circuits the labor market and trips up the economy.
The U.S. unemployment rate has only just dropped to 3.6 percent, near the pre-pandemic level, and any large reversal could be a prelude to a recession.
The Fed has managed ‘soft landings’ infrequently in the past, analysts say, and at this point has allowed inflation to rise so much faster than interest rates that it may have already missed its chance to do so.
And while it is expected to raise rates rather quickly now to compensate, the inflation path will also depend on a number of factors beyond the Fed’s control, including the evolution of the pandemic, the war in Ukraine, and ongoing supply and labor shortages connected to both.
The Fed’s plan to reduce its balance sheet will also be a focus on Wednesday. While the broad outlines were disclosed about three weeks ago in minutes of the Fed’s March meeting, investors expect to learn details of the speed and extent of the plan, including possible MBS sales at some point in the future.