The Fed in limbo
Jerome Powell will go down in the economic history books as the name associated with the first 75 bp hike in the US central bank’s key rate in nearly 30 years. He thus succeeds Alan Greenspan, the last head of the Federal Reserve to have instigated such a move in 1994.
But this highly significant rate increase has hardly come as a surprise. An unexpected uptick in inflation in May 2022, coupled with a sharp rise in US households’ inflation expectations for the next 5 to 10 years, meant that investors had largely priced in this scenario. And it could be repeated in July. From this point of view, the Fed has therefore lived up to expectations. The same is true of upward revisions to its forecasts for end-of-year inflation and key rates – raised to 3.4%, implying an increase of at least another 175 bps – and the lowering of its growth outlook. The latter is down to 1.7% for 2022, versus the 2.8% anticipated at the March meeting, and 4.0% at the December 2021 meeting. Setting aside any concerns that may be triggered by a further acceleration of monetary tightening, these factors can be viewed in a fairly positive light: the Fed is determined to actively fight inflation and will not back down, despite being aware of the risk to economic growth. Certain changes to the initial statement from the monetary policy committee (FOMC) conveyed the same message.
Nevertheless, Jerome Powell’s comments during his speech were much less transparent. He reaffirmed that there was a track for a soft landing, bringing down inflation without destroying growth, and ruled out any risk or desire for a recession. Admittedly, it would have been hard for the Fed chief to say anything different, but it does rather contradict the FOMC’s sharp downward revision of the growth outlook. Especially since Jerome Powell subsequently qualified his remarks, explaining repeatedly that the trajectory of the US economy was increasingly dictated by external factors: the conflict in Ukraine, Covid in China, oil prices, bottlenecks, etc. He also acknowledged that while the central bank was “very alert” to the danger of going too far, it could not risk a failure to reduce inflation. In other words, the momentum of inflation is more crucial than that of growth. It is difficult for investors to find their feet in this game of shadows, in which everyone, be they optimist or pessimist, can find something to support their opinion. Perhaps this is actually what the Federal Reserve is seeking to achieve, until it is able to see things more clearly itself.
This is another lesson that can be learned from this Fed meeting. We knew the Federal Reserve would be flexible and that it was “data dependent” (that is, adapting to recent economic data), but rarely has it seemed to be playing it so much by ear. A prime example of this is its 75 bp rate hike (in response to figures released a few days earlier) rather than the 50 bp rate hike it had been signalling far and wide for several weeks.
The words of Jerome Powell offer the most insight in this regard. On both growth and inflation, the Fed chair frequently repeated, in the last part of his press conference, that “we just don’t know”. Was this a possibly beneficial exercise in honesty, or an admission of helplessness in the face of a situation where there is only so much under the central bank’s control? It was surely a bit of both, amid what is ultimately quite a sharp reduction in clarity as to the trajectory of US monetary tightening and the Fed’s ability to solve the inflation/growth equation. Although the Fed seemed to have the situation fully under control a few weeks ago, today there is nothing to reassure markets that are already extremely nervous.
Final version of 17 June 2022
Enguerrand Artaz, Fund Manager
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