Like a junkie pleading for another fix, the financial markets tanked again last Friday after St. Louis Federal Reserve Bank President James Bullard told CNBC that he sees the Federal Reserve raising interest rates before the end of next year, a year or so before the Fed announced two days earlier that it plans to do so.
This is surely ironic since in the years following the 2008 financial crisis, Bullard was one of the most dovish members of the Fed, reliably arguing for monetary accommodation long after his fellow Fed members had moved on to raising interest rates. Now it appears that Bullard, based on his comments last week, has turned positively hawkish, at least compared to his Fed brethren.
"I put us starting in late 2022," Bullard said. "This is a bigger year than we were expecting, more inflation than we were expecting. I think it's natural that we've tilted a little bit more hawkish here to contain inflationary pressures."
By contrast, following the end of its June monetary policy meeting two days earlier, the Fed indicated that it doesn't expect to raise interest rates until the end of 2023. Yet that set off a selloff in the markets because it was more aggressive than its previous estimate in March when it said it didn't expect to raise rates until 2024 at the earliest.
The Fed's updated median outlook is now calling for up to two rate increases in 2023. According to the Fed's new "dot plot" projections, 13 of 18 Fed voting members expect to raise short-term rates by the end of 2023, up from seven in March. Back then, most members anticipated holding rates steady through 2023.
Bullard isn't currently a voting member of the Fed's monetary policy committee, but he will be next year.
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What's most interesting is that the Fed has created this investor skittishness by merely saying that it doesn't expect to raise interest rates for another two years—not two months, not two quarters, but more than two years from now. Then Bullard comes along and says it may be a little less than that, but still more than a year from now. You would think that would give the market plenty of time to adjust. After all, just about everyone—outside the Fed—already believes that inflation and economic growth are running plenty hot enough to justify some type of Fed tightening, even as early as this year, never mind next year or the year after.
According to its updated economic forecasts released last week, the Fed now believes that U.S. GDP growth will hit 7% this year, up from its March projection of 6.5%, before receding to a still-robust 3.3% next year and 2.4% in 2023. It also projects core inflation—excluding food and energy prices—to reach 3.0% this year before falling to a little above 2.0% after that, meaning it's sticking to its belief that current inflationary pressures will be "transitory."
That's debatable. In May, the core consumer price index rose 3.8% on a year-on-year basis—the biggest increase since June 1992—while the producer price index jumped by 4.8%. Inflation has now been running hot for three months.
The Fed also said it has no plans to reduce its massive asset purchase program and thus will continue to buy at least $80 billion per month of Treasury securities and another $40 billion of mortgage-backed securities. The Fed's balance sheet now totals just under $8 trillion, with about $1 trillion of that added just in the past year.
"You can think about this meeting that we had as the 'talking about talking about tapering,' if you like," Fed Chair Jerome Powell said at his post-meeting press conference.
While the Fed is taking its sweet old time about normalizing monetary policy, if that's a thing anymore, that's even too aggressive for the markets to handle, apparently. Here is the Fed signaling that it doesn't plan to raise interest rates for more than two years and provided no signals that it plans to reduce, even slightly, its asset purchases. Yet, investors are in a mini-panic that the 12-year-old bull market, dating from the previous financial crisis, is about to come to an end.
The market's reaction to the Fed announcement and Bullard's comments illustrates just how dependent it is on the Fed's easy monetary policies and just how much the Fed has inflated financial assets over the past dozen years. While the Fed has certainly done a lot to keep the economy moving and ease two financial crises over that time, it's also artificially inflated asset prices and fueled rampant speculation. Allowing these policies to continue for another two years or so while the economy is running in overdrive seems reckless.
The markets should be thankful that the Fed is allowing these policies to run another two years rather than acting like the end is near. It isn't.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.