Jerome Powell targets Inflation control, whatever the cost

18 May 2022 , 01:35 PM

The global economies are in a state of flux and that has largely been driven by the extreme hawkishness shown by the US Fed, especially its chairman Jerome Powell. It is therefore obvious that every public statement of Jerome Powell is now being scanned with a fine toothed comb to look for implications. Fortunately, Powell has been quite often blunt and straight in his talk, rather than giving across very subtle hints.

The latest statement was made during Powell’s address at the Wall Street Journal’s “Future of Everything Festival”. Powell underlined that the Fed would hike rates as long and as much as required to ensure that inflation is brought under control. Powell did not mince words in stating that the Fed would be even OK with taking the rate of interest to 4% instead of 3% over the next 12 to 18 months.

The impact was visible immediately after this statement. Dollar Index (DXY) bounced back from 103 to 103.50 while the bond yields once again bounced back to 2.98%. But the real effect was seen in the upward shift in probabilities of the CME Fedwatch.

CME Fedwatch sees probability of rate hikes shifting higher

CME Fedwatch captures probability of rate hikes at future meetings based on the yields implied in  futures trading. Probabilities trended sharply higher after the WSJ address by Jerome Powell. Here are the latest probabilities for the next 10 meetings of the FOMC.

Fed Meet	125-150	150-175	175-200	200-225	225-250	250-275	275-300	300-325	325-350	350-375	375-400
Jun-22	88.4%	11.6%	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil
Jul-22	Nil	Nil	80.1%	18.8%	1.1%	Nil	Nil	Nil	Nil	Nil	Nil
Sep-22	Nil	Nil	Nil	29.7%	57.4%	12.2%	Nil	Nil	Nil	Nil	Nil
Nov-22	Nil	Nil	Nil	Nil	26.8%	54.7%	16.6%	1.8%	0.1%	Nil	Nil
Dec-22	Nil	Nil	Nil	Nil	Nil	25.8%	52.7%	18.7%	2.6%	0.2%	Nil
Feb-23	Nil	Nil	Nil	Nil	Nil	12.3%	38.6%	36.8%	10.9%	1.4%	0.1%
Mar-23	Nil	Nil	Nil	Nil	Nil	4.9%	22.9%	37.8%	26.4%	7.1%	0.9%
May-23	Nil	Nil	Nil	Nil	Nil	4.0%	19.5%	32.1%	28.5%	10.6%	2.2%
Jun-23	Nil	Nil	Nil	Nil	Nil	3.5%	17.6%	33.2%	29.3%	12.8%	3.5%
Jul-23	Nil	Nil	Nil	Nil	Nil	3.5%	17.5%	32.9%	29.2%	13.1%	3.8%

Data source: CME Fedwatch

With the current Fed funds rate in the range of 0.75% to 1.00% (after rate hikes in March and May), here is a quick look at how the rate hike expectations pan out over the next 10 meetings of the FOMC.

1. Unlike about 15 days back when the Fed issued its May statement, the latest speech by Jerome Powell has led to much greater clarity on the probabilities of rate hikes. There is a sharp consolidation of probabilities.
2. Markets are anticipating 50 bps rate hike in June 2022, July 2022 and September 2022 FOMC meetings. The Fedwatch is pencilling in rate hikes of 25 bps each in November and December 2022, taking the rates to the range of 2.75% to 3.00% by December 2022.
3. The real shift has happened in the probabilities beyond December 2022. About 15 days back, the expectations picture beyond December 2022 was relatively hazy. However, after the Powell WSJ address, the Fedwatch is veering towards rates touching the range of 3.50% to 3.75% by June 2023. That is the big change that has happened.

Jerome Powell stating that inflation control was non-negotiable, has changed the complete structure of rate hike probabilities.

Inflation control at all costs, says Powell

Speaking at the Wall Street Journal’s Future of Everything Festival, Jerome Powell made two very significant statements. This is not exactly a departure from his past statements but it only intensifies the resolve of the FOMC to use the rates tool aggressively to control inflation. Here are the 2 statements that Powell made.

• “The Fed’s resolve in combating the highest inflation in 40 years should not be questioned or doubted. It will remain unflinching in this direction, even if it means pushing up unemployment.”
• “The Fed’s stopping point for rate increases is not certain. If inflation does not show signs of diminishing soon, more FOMC members could conclude that rates need to rise closer to 4% over next 12 to 18 months, rather than just 3%.”

In the last few weeks there have been several debates on this subject of rate hikes. There have been concerns by economists that the rate hikes should have happened much earlier and the Fed perhaps delayed the decision too much. The other concern expressed by the likes of Larry Summers is that rapid rate hikes could result in a recession and a slowdown in the economy, with all its logical deleterious effects. Summers and others raised doubts over controlling inflation with rate  hikes when the unemployment levels were at a historic low of 3.6%. That is true, because sharp wage hikes could offset inflation reduction.

However, Powell is a lot more pragmatic about the entire issue. According to Powell, it is hard to simulate answers since the US economy has not exactly been in this kind of a situation before. Hence policymakers will have to tackle the situation as it comes. Powell did express confidence that inflation control need not be at cross purposes with a soft landing. With a proper amalgam of fiscal and monetary strategies, it was economically possible to bring down inflation, while ensuring a soft landing. That is something we best leave for the future to decide.

What does Fed hawkishness mean for the RBI?

The RBI has already made its stand clear with the unscheduled rate  hike of 40 bps in May 2022. The RBI also amplified the impact with a 50 bps hike in CRR. However, if the Fed targets 4% instead of 3% by June 2023, then RBI may have a problem on hand. In that case, the RBI rate strategy would have to go beyond just reversing the COVID cuts. Currently, the RBI has another 75 bps cushion to hike without being hawkish. However, the Fed shift in stance, may make the RBI more hawkish, beyond just a COVID reversal.

For now, the RBI would focus less on the US consumption inflation and more on the US PCE (personal consumption expenditure) inflation that the Fed uses for its rate decisions. That data will be out on 27th May, and is likely to be an important trigger for how the RBI would formulate its rate policy in the coming months.