Federal Reserve Chair Jerome Powell almost guaranteed that rate increases were coming, but the “implications for the U.S. economy” from the Ukraine–Russia war “are highly uncertain.”
Speaking to House and Senate committees, the head of the central bank anticipated quarter-percentage-point increases ahead. Powell conceded that there would always be the possibility that the Fed could accelerate rate hikes should inflation spiral out of control.
Powell confirmed to lawmakers that the Fed is monitoring the situation in Eastern Europe “closely,” adding that the institution must “be nimble in responding to incoming data and the evolving outlook.”
“The bottom line is that we will proceed, but we will proceed carefully as we learn more about the implications of the Ukraine war on the economy,” he said.
Monetary policymakers are now steering the U.S. economy through turbulent waters.
Russia’s invasion of Ukraine has sent crude oil prices above $116 per barrel, the highest level in about a decade. Natural gas prices are also closing in on $5 per million British thermal units (Btu).
The consumer price index (CPI) climbed to a 40-year high of 7.5 percent in January. In addition, the personal consumption expenditure (PCE) price index, the Fed’s favorite inflation gauge, expanded at the fastest pace since 1983, clocking in at 5.2 percent year-over-year.
There’s also an intensifying concern about sluggish first-quarter growth.
The Fed Bank of Atlanta slashed its first-quarter gross domestic product projection to zero, from 1.7 percent in the previous estimate.
“The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2022 is 0.0 percent on March 1, down from 0.6 percent on February 25,” it wrote.
“After recent data releases from the U.S. Census Bureau and the Institute for Supply Management, an increase in the nowcast in first-quarter real personal consumption expenditures growth from 1.6 percent to 2.3 percent was more than offset by a decline in the nowcast of the contribution of net exports to first-quarter real GDP growth from -0.10 percentage points to -0.94 percentage points.”
Fast or Slow? Fed Officials Weigh Interest Rates
St. Louis Federal Reserve President James Bullard reiterated his support for boosting rates, telling the regional business group Greater St. Louis Inc. that “the economy has shown tremendous resilience” and “it is the Fed’s responsibility to control inflation.”
He refrained from listing the size of the rate increase, but Bullard has previously recommended 100 basis points by July.
Chicago Fed President Charles Evans conceded to the Lake Forest-Lake Bluff Rotary Club Foundation in Chicago that the inflation rate will stay above 3 percent for the rest of the year. Evans acknowledged that the central bank is poised to raise rates multiple times in 2022, purporting that it’s “crucial” to curb four-decade-high prices.
Evans also stated that the institution would begin trimming its “very large” $8.89 trillion balance sheet.
Speaking during a discussion hosted by the Maryland Chamber of Commerce, Richmond Fed President Tom Barkin was blunt in purporting that “it is timely for us to normalize policy.”
Barkin noted that the next logical step is to increase rates because the labor market is strong, inflation is broad and high, and consumer demand is immense.
But could the worsening crisis in Eastern Europe derail the Fed’s plans?
“We’re going to have to see whether this Ukrainian situation changes that narrative. And I just think time will tell,” Barkin said.
“And so if this evolves like 2014, I don’t think you’re going to see much change to the underlying logic. We’re not that engaged with the Russian economy. There may be more to Europe.”
While the consensus is that the Fed will be more cautious about policy normalization by raising the fed funds rate by 25 basis points, financial markets shouldn’t rule out a 50-basis-point increase amid red-hot inflation, says Fed Governor Christopher Waller.
“With the economy at full employment and inflation far above target, we should signal we are moving back to neutral at a fast pace, based on the performance of the economy, and a 50-basis-point hike would help do that,” Waller said at an economic forecasting conference at the University of California.
He did say that the Fed and other central banks may need to adopt “more modest tightening” in the wake of the military conflict in Kyiv.
At an American Bankers Association (ABA) event, Fed Governor Michelle Bowman stressed the importance of “normalizing our interest rate stances and significantly reducing the size of the Federal Reserve’s balance sheet” amid high inflation and a strong labor market.
What Does the Market Expect?
According to the CME FedWatch tool, the financial markets are penciling in a quarter-point increase to the target rate. Traders are pricing in five quarter-percentage-point increases.
JPMorgan Chase analysts expect the Fed will pull the trigger on nine rate increases through March 2023. Morgan Stanley thinks the FOMC will agree to boost rates six times this year, totaling 150 basis points. Wells Fargo anticipates four rate hikes in 2022.
Whatever the number is, the “case for tighter monetary policy remains strong,” says James Knightley, ING’s chief international economist.
“It is obviously difficult to call how the geopolitical backdrop will evolve, but our central case for now is the Fed responds with six hikes this year and announces a gradual, passive run-down of its $9tr balance sheet in late 2Q,” he said in a note.
The FOMC will finish its two-day policy meeting on March 16.