Last week a bevy of Federal Reserve officials led by New York Fed President John Williams, "who is one of the most senior advisers to Chairman Jerome Powell and helps shape the policy agenda," in the words of the Wall Street Journal, tried to talk down the market's concern that the Fed is about to ratchet up interest rates aggressively, starting with a 50-basis point hike at its next meeting March 15-16.
"There's really no kind of compelling argument that you have to be faster right in the beginning" with rate increases, Williams said last Friday. "There's no need to do something 'extra' at the beginning of the process of liftoff. We can…steadily move up interest rates and reassess. I don't feel a need that we'd have to move really fast at the beginning."
The 50 bp talk got started by St. Louis Fed President James Bullard, who had said earlier that "the best response to this situation [meaning the recent surge in inflation to 40-year highs] is to front-load the removal of accommodation." That provoked a large selloff in the stock and bond markets. Subsequently, several Fed officials and regional bank presidents, including Williams, pushed back on that assessment, saying that the Fed would take a more measured approach to raising rates. The desired path now seems to be a 25-bp increase at the March meeting, following which the Fed would see what effect that would have before taking the next step.
"It's going to take a series of rate increases and seeing how the economy respond... to really get a good gauge on what's going to be required of us," Kansas City Fed President Esther George said.
Now, it's hard to believe that one quarter-point increase in the fed funds rate is going to have much effect on stifling 7%-plus inflation and that more can be expected going forward.
However, Fed officials continue to repeat the mantra that their decisions will be "data-driven." In addition, although the Fed appears to have "retired," in Powell's words, the word transitory to describe inflation, it still seems to believe that it is only temporary, just not as transitory as it previously believed. Indeed, many analysts outside the Fed have been saying lately that inflation may have peaked and that it may start to recede in the next few months as supply chain bottlenecks start to ease along with the spread of Covid19.
Then there's Russia, whose threatened invasion of Ukraine has driven up the price of oil to near $100 a barrel, a big reason behind the rise in inflation and turmoil in the financial markets.
It's reasonable to expect that if Russia follows through on its threats and does invade, the Fed would further moderate its approach to monetary policy. Would it really push through one rate increase after another in the face of a large international crisis like this?
Some analysts have posited the idea that the Fed can't do much if Russia marches into Ukraine. That's not entirely true. While it can't stop the tanks from moving in, it can certainly loosen monetary policy, or hold off tightening, in this case, to ease worries in the financial markets. It did no less than that after the U.K. voted to leave the European Union in 2016. If the S&P 500 dropped 10% or more if the Russians invaded, would the Fed really continue to raise interest rates every month or so? That's a little hard to imagine.
As I noted in my previous column, the Powell Fed has shown no hesitancy to ease monetary policy in response to some kind of emergency, but no sense of urgency to tighten back up when those conditions recede. Pretty much everyone acknowledges that the Fed has been "behind the curve" on being concerned about inflation, including people on the Fed. "The current stance of monetary policy is wrong-footed and needs substantial adjustment," Chicago Fed President Charles Evans said at the same conference where Williams spoke. Yet Williams believes there is "no kind of compelling argument" to raise rates aggressively at this time. That just fits in with the recent Fed response to rising inflation, which is basically to sit and do nothing until March. The fact is, the Fed appears to be in no hurry to reverse monetary policy from accommodative to restrictive, so for the financial markets to expect anything different seems foolish.
So the investor response to all this is to follow the Fed, not try to outthink it. The Fed may indeed be wrong about its assessment of inflation, or at least have a different opinion than everyone else, but it's going to do what it's going to do and nothing else. If that means we have to sit and wait to see what happens, then so be it. There's no reason to start bailing before the water is in the boat.
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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.