Financial basis

Dissecting Recent Fed Discussions — Central Bank Set to Make Two Half-Percentage Point Moves for Summer

April’s disappointing consumer price inflation report focuses on the Federal Reserve and its plans to reduce inflation.

Many Fed officials have spoken this week. Here are some of the main themes that emerged at the next policy meeting in just over a month:

We will move by 50 basis points in June and July. Next question.

At his May 4 press conference, Fed Chairman Jerome Powell said, “There is a general feeling within the committee that further increases of 50 bases should
To be sure, 50 basis points should be on the table for the next two meetings. Fed speakers this week all embraced this plan.

75 basis points isn’t ‘off the table’, but it will take a lot – emphasizing a lot – for that to happen

Early in his press conference, the focus was on what Powell would say about the last-minute idea that popped up just before the central bank went silent: Could policymakers raise rates? in 75 basis point increments? Powell said such a large move “is not something the committee is actively considering.” This was seen as a clear “fumble” by Fed watchers and some investors, who argued that Powell should not have taken the “optionality” of a larger move off the table.

Lily: ‘Unbalanced’ markets followed Fed’s Powell ‘unforced error’, says David Tepper

This view gained credibility following the heavy stock market losses that followed.

Fed officials therefore did not remove the option from the table.

“To counter these criticisms, they have done everything possible to keep potential 75 basis point upsides as an option, but with some substantial caveats,” said Tim Duy, chief US economist at SGH Macro Advisors.

Cleveland Fed President Loretta Mester put it succinctly: “We’re not ruling out 75 forever.”

Duy thinks the Fed would not move 75 basis points unless surveys and data show the public comes to believe that higher inflation is here to stay. It would be an “icebreaker” moment for the central bank.

How high will the Fed’s benchmark rate eventually have to go to bring inflation down? Next question.

Fed officials remain remarkably cautious about how high their benchmark interest rate will need to rise to bring inflation down. Powell only said the rate may need to hit the 2.5% to 3% range. Many Fed speakers stick to saying they want to go to “neutral” — somewhere near 2.5% — and then they’ll look around.

These responses are driving hawkish observers — and even some former Fed insiders — mad. They note that standard monetary policy theory suggests that the central bank will need to drive rates higher than core PCE inflation (now at an annual rate of 5.2%) to bring inflation down.

Former New York Fed Chairman Bill Dudley said the Fed’s benchmark rate will eventually need to rise to 4%-5%.

“I was 3%-4% maybe six months ago, now I’m 4%-5%. It wouldn’t shock me if I was [at] 5% to 6% in a few months,” he said in an interview with Bloomberg. Dudley said the Fed is “mitigating” how difficult it will be to bring down inflation.

“If you continue to underpromise what is required, then I think there is a credibility risk for the Fed down the road,” he added.

Duy of SGH Macro Advisors said he thinks policymakers are keeping quiet because they don’t want financial markets to “get too far ahead of the central bank”. After all, the Fed’s key rate is now in a range of 0.75% to 1%.

“Too high pricing now risks creating destabilizing turbulence in the market,” Duy said.

We really don’t think the economy will collapse

Fed officials have uniformly tried to push back against the idea that a recession is inevitable. This view seems to be entrenched in bond market opinion as well as popular media.

Policymakers “appear confident in their ability to achieve a soft landing,” said Rubeela Farooqi, chief U.S. economist at High Frequency Economics.

New York Fed President John Williams said a soft landing could imply below-trend growth [2%] and despite a possible increase in unemployment, the labor market should remain healthy.

“When I think of a soft landing, it’s really a matter of, yes, we could see below-trend growth for a while and we could definitely see unemployment go up somewhat but not hugely. I think that’s the challenge,” he said. .

The yield of the 10-year Treasury note TMUBMUSD10Y,
2.911%
pulled higher in the CPI’s April data earnings, but then pulled back.

Stock index futures wiped out gains following the CPI data, while stocks then traded higher after the opening bell, only to tumble into negative territory in trading for the afternoon. The Dow Jones Industrial Average DJIA,
-0.67%
was down 161 points, or 1.1%, while the S&P 500 SPX,
-1.05%,
which recorded its lowest close in more than 13 months on Monday, fell 0.8%.

Read next: Why the inflation data wasn’t a “watershed moment” for stock and bond investors