Fed tries to match economic risks against market's rush to tighten
WASHINGTON (Jan 24) - The Federal Reserve may not raise interest rates until March, but officials' tougher language about inflation is already kicking in, with borrowing costs rising for everyone from homebuyers to the federal government and stock markets kicking off the year deep in the red.
The pace of that adjustment now poses an unexpectedly urgent question for U.S. central bank officials at their latest two-day policy meeting this week: Are financial markets tightening too fast for what the Fed intends in its inflation battle, or is the Fed the one underestimating what will ultimately be needed to slow the pace of price increases?
In their most recent projections, issued in December, policymakers said they expected as many as three quarter-percentage-point rate increases this year, with more in the cards in 2023 and 2024. But those projections never raise the Fed's benchmark overnight interest rate above the "neutral" level that would actually restrict the economy.
Yet inflation still falls, a best-of-all-worlds outcome some analysts see as unrealistic.
"The U.S. is facing the highest inflation since 1982 and there is compelling evidence that a good chunk of it will persist. The Fed has never responded this slowly ... and even today is signaling a benign hiking cycle," wrote Ethan Harris, the head of global research at Bank of America. "The biggest near-term risk is right in front of us: that the Fed is seriously behind the curve and has to get serious."
That could mean as many as six quarter-percentage point rate increases this year, he said, and a fast push to a 3% federal funds rate from the current level near zero. That'd be the highest policy rate since the Fed started slashing borrowing costs at the start of the 2007-2009 financial crisis, and enough, according to current estimates, to actually curb economic growth, employment and inflation.
In the Fed's current projections they merely do less to prop it up.
Fed officials won't update their formal outlook at the Jan. 25-26 policy meeting. But Fed Chair Jerome Powell will hold a news conference after the release of the policy statement on Wednesday to talk in more detail about the Fed's plans, the current view of the economy, and the recent resetting of rates and equity values. That has included a more than 7% decline in the S&P 500 (.SPX) index since Dec. 31.
'SHADOW' RATE HIKES
For a central bank that just a few months ago still promised open-ended support until the economy was fully healed from the coronavirus pandemic, the surge in U.S. inflation to a 40-year high kickstarted a high-stakes policy shift away from pandemic support.
Reuters
