Powell Opens Door to Faster Rate-Hike Path to Curb Inflation

© Reuters. Powell Opens Door to Faster Rate-Hike Path to Curb Inflation

(Bloomberg) -- Jerome Powell made clear the Federal Reserve would act as needed to cool the hottest inflation in almost 40 years, endorsing interest-rate liftoff in March and opening the door to more frequent and potentially larger hikes than anticipated.

Stressing uncertainty on the economic outlook, including the risk that price pressures could fail to abate as forecast, the Fed chair told reporters on Wednesday that policy must be “nimble” to confront risks to its mandate for price stability and maximum employment. Investors took the comments to mean the Fed would be more aggressive in tightening than previously expected.

As Powell spoke during a 55-minute virtual press conference, stocks erased gains, bond yields surged and the dollar advanced. The S&P 500 index posted a back-to-back drop after rallying more than 2% earlier in the day, while the two-year Treasury yield had the largest one-day increase since March 2020.

“There’s a risk that the high inflation we’re seeing will be prolonged, there’s a risk that it will move even higher. We have to be in a position with our monetary policy to address all of those plausible outcomes,” Powell said, adding that officials were “of a mind” to raise rates in March. 

He spoke after the Federal Open Market Committee confirmed it would end its asset purchase program in early March and begin shrinking its bond holdings after rate increases commence.

The hawkish pivot, against a backdrop of turmoil in stocks, comes amid consumer inflation readings that have repeatedly surprised and hit 7% -- the most since the 1980s -- and a tight labor market that’s pushed unemployment down faster than anticipated to almost its pre-pandemic level.

“The implication was they would probably have to go a bit further and a bit faster than people were anticipating,” former New York Fed President Bill Dudley told Bloomberg Television. “I don’t think he committed to doing every meeting. I think what he committed to is ‘we’re probably going to end up doing quite a bit more than people had anticipated’.” Dudley is a senior adviser to Bloomberg Economics.

What Bloomberg Economists Say

“The hawkish tone of the statement and Chair Jerome Powell’s press conference suggests there’s upside risk to the four rate hikes priced in by financial markets ahead of the meeting. Bloomberg Economics forecast earlier this month the year will probably end with a total of five hikes, with an upside risk for six.”

-- Anna Wong, Yelena Shulyatyeva, Andrew Husby and Eliza Winger

A rate hike would be the central bank’s first since 2018, with many analysts forecasting a quarter-point increase in March to be followed by three more this year and additional moves beyond. Critics say the Fed has been too slow to act and is now behind the curve in tackling inflation, though key market gauges don’t back that view. 

Even some Fed officials have publicly discussed if they should raise rates more this year than forecast. In December their median estimate was for three hikes in 2022. Powell made a point of saying that the economic projections would be updated in March.

“The Fed is clearly looking through omicron and will not react to weak data for January and February,” Bank of America Corp (NYSE:BAC). economists led by Ethan Harris said in a note. “Bottom line, the risks are skewed to more than four hikes this year.”

Futures indicated around 30 basis points of tightening at the March meeting, showing a quarter-point increase is fully priced and implying a one-in-five chance of a 50 basis point hike.

Officials held the target range for their benchmark policy rate unchanged at zero to 0.25% as expected. They also said they will conclude asset purchases on schedule, leaving them on track to end in “early March.”

The Fed’s balance sheet stands at nearly $8.9 trillion, more than double its size before officials began massive asset purchases at the onset of the pandemic to calm market panic.

In a separate statement outlining the principles it would apply to reducing its balance sheet, the Fed said that over the longer run, it intends to primarily hold Treasury securities. The Fed currently also holds mortgage-backed securities and the shift is aimed at minimizing its effect “on the allocation of credit across sectors of the economy,” it said. 

Powell said the Fed will make decisions on the timing and pace of balance-sheet reduction at coming meetings.

Despite criticism that it has dragged its feet, the Fed is moving much quicker than it once expected to -- prompted by the failure of inflation to fade as anticipated amid robust demand, snarled supply chains and tightening labor markets. As recently as September, central bank officials were split on whether any rate hikes would be warranted in 2022.

The meeting is the last of Powell’s current term as Fed chair, which ends in early February. He’s been nominated to another four years at the helm by President Joe Biden and is expected to be confirmed by the Senate with bipartisan support. 

©2022 Bloomberg L.P.