Federal Reserve officials have not done enough to dispel rising market expectations that the U.S. central banks will raise interest rates by half of a percentage point in May in order to stem the inflation surge. However, they aren’t dispelling concerns that the tightening cycle could cause a recession in the economy or the labor market.
James Bullard, the president of St. Louis Fed, said Tuesday that the Fed must move quickly to control inflation. He reiterated his demand for the central bank’s benchmark overnight rate to rise to 3% this year. He said, “Faster than usual”
Bullard, who voted against the Fed’s decision to raise the federal fund’s rates by only a quarter of a percentage point from its near-zero level last week, has previously made the same point. His view seems to be gaining ground.
Jerome Powell, Fed Chair, stated Monday that the central bank must act “expeditiously”, in order to raise rates. He said nothing when asked about what could stop the central bank from raising rates by half of a percentage point at the May 3-4 policy meeting.
These comments led to a flood in futures markets betting on half-point increases in interest rates in May and June. The traders now expect the federal funds rate to rise to the 2.25%-2.5% range by year’s end – less than Bullard’s view, but higher than the 1.9% forecast by Fed last week.
Powell stated that the economy is strong enough for higher borrowing costs to not damage the labor market. He also argued that the Fed should control inflation to maintain labor market strength.
However, traders now place bets that next year the Fed will begin to reduce interest rates.
“The fixed income market does not believe Powell’s optimism about the economy: It is telling me that a soft landing if Powell’s path is followed by the Fed will not only be difficult, but impossible,” said Roberto Perli, an economist with Piper Sandler.
‘HAWKISH PIVOT’
It looks like a difficult start for the Fed’s third round of rate increases in three years. This is especially true for the way its policymakers communicate it.
Powell stated that the Fed would continue to increase interest rates “carefully” ahead of last week’s decision. This was due to the high degree of uncertainty surrounding the economic impact of the Russian invasion on the U.S.
Following the release of the Federal Open Market Committee’s (FOMC) policy statement, projections and an accompanying news conference, Powell stated that the Fed must respond quickly to changing outlooks.
This week, the Fed chief downplayed concerns about the possible impact on economic growth and emphasized the possibility that the war in Ukraine could increase U.S. Inflation. The latter has reached a 40-year high and is three times the central bank’s 2% target.
According to Kevin Cummins, a NatWest economist, the changes could be a reflection of Powell’s personal “hawkish pivot”, which began in late 2021.
Cummins stated that Powell’s comments in the near term are not definitive about the expected size of the rate hike in May. This is especially true considering the May FOMC meeting will not be for six more weeks. Fed actions will be driven primarily by data.” Cummins added.