The Fed: Fed to hike interest rates Wednesday, undeterred by lack of visibility on Russia-Ukraine war’s impact
On Saturday, a strong late winter storm caused havoc on the East Coast, particularly in Pennsylvania, with drivers experiencing severely reduced visibility as winds blew snow across the roads. Speed limits were reduced and trucks restricted to the right lanes of highways.
It is a fitting metaphor for the U.S. economy, the Federal Reserve and Chairman Jerome Powell.
Fed policy makers know they have to start raising interest rates given the low unemployment rate and inflation at 40-year highs. The Fed has to move even though the wisest course of action might be to delay until the impact from the war in Ukraine on the U.S. economy is more clear.
Economists are already trimming their U.S. economic growth outlooks while raising their inflation forecasts as a result of the conflict.
Even before the war, the Fed was walking a narrow path — attempting to cool inflation without causing a recession, said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. “Receiving another meaningful supply-side shock to the economy has only made that path narrower for them,” he said.
These conditions will prompt the Fed “to perhaps move more carefully initially” but given the spike in energy costs, ultimately “move more aggressively down the road,” Luzzetti said in an interview.
Powell is going to do what any driver in a storm should — slow down and not make any sudden moves to surprise others on the road. And that is just what the Fed chairman has done.
Two weeks ago, Powell publicly stated he favors a 25-basis-point rate hike, atypical telegraphing for a Fed head. “But these are atypical times,” said Michael Gregory, head of U.S. economic at BMO Capital Markets in a note to clients.
So a quarter-point hike is considered a done deal.
Read: Powell signals rate hike is coming in two weeks
Powell also warned Congress that visibility on the policy outlook was pretty low — and that is likely to be a recurring theme of Wednesday’s news conference, said Lou Crandall, chief economist at Wrightson ICAP.
The Fed will release its policy statement at 2 p.m. Eastern on Wednesday and Powell will follow up with a press conference at 2:30 p.m.
Still, although some of the drama has been removed from Wednesday, the details matter for the market, said Josh Shapiro, chief U.S. economist at MFR Inc.
“It’s one of those weird meetings where everybody kind of knows what is going to happen, but nobody has any idea what’s going to happen,” Shapiro said, in an interview.
Most important, Shapiro said, will be the way Powell discusses the fallout from Ukraine. That will “give a hint” as to what the Fed is thinking in terms of the speed of tightening, he said.
Read: Ukraine invasion stokes stagflation worries because Russia is a ‘commodity superstore’
Luzzetti of Deutsche Bank said the most important element on Wednesday will be if the Fed sets parameters around the shrinking of its nearly $9 trillion balance sheet.
The Fed will let its balance sheet shrink by allowing maturing securities to roll off its portfolio. But it will set monthly caps to make this an orderly process. Announcing the caps would signal that the Fed could announce the start of the reduction at their next meeting in May.
Economists will be also looking at the Fed’s “dot plot” of rate-hike expectations. At the moment, traders in the Fed funds futures market expect just under seven quarter-point rate hikes in 2022. In December, the Fed projected three hikes this year.
Luzzetti said the Fed’s guidance on rate hikes cannot extend very far given the uncertainty, but action on the balance sheet “will speak louder than words.”
Steve Englander, head of North America macro strategy at Standard Chartered Bank, said Fed policy can be divided into three stages.
The first stage, starting Wednesday, is where the policy direction is obvious and on automatic pilot. Fed policy is at an ultra-easy stance even with the unemployment rate at 3.8% and inflation at a 40-year high.
The second stage will come after a first round of rate hikes, when the Fed gauges the underlying momentum of the economy.
“The reason this stage is needed is that the Fed, like the rest of us, has a very imperfect idea of underlying momentum, structural factors, unmeasurable forces affecting confidence, and the impact of monetary policy,” he said.
Englander said this stage might come after four 25 basis-point hikes, but this is uncertain.
The third, and final stage, comes from dealing with unforeseen outcomes. In 2019, this meant the Fed backed off plans to hike rates. In the 1970s, it meant that inflation was more powerful than expected.
The yield on the 10-year Treasury note
rose to 2.1% on Monday, its highest since 2019. Yields, which move in the opposite direction of prices, have rebounded after falling sharply in the immediate aftermath of Russia’s Feb. 24 invasion of Ukraine.
Stocks were mostly lower Monday as investors weighed Russia-Ukraine developments and prepared for the Fed meeting. The Dow Jones Industrial Average
was holding on to a gain of around 140 points, or 0.4%, while the S&P 500
See: ‘Unprecedented territory’: Stocks slump on Russia-Ukraine war as jittery investors watch for Fed to start hiking rates amid high market volatility