Back to basics for the Fed

Jerome Powell is expected to emphasize his willingness to remain nimble, and to stand ready to raise rates more aggressively if necessary, with increases of more than 0.25% in the event of stronger or more persistent inflation.

• No surprise to expect from the next FOMC: the Fed should announce a rate hike of 0.25bp to combat ever-stronger inflation.
• The Federal Reserve should also emphasize its willingness to remain nimble, and stand ready to raise rates more aggressively if necessary.
• The markets should remain calm in the face of a decision for which they are largely prepared.

There are no surprises to be expected from the next meeting of the Fed’s Monetary Policy Committee (Federal Open Market Committee – FOMC), which should announce a first rate hike of 0.25bp. Fully determined not to add stress to the already highly volatile markets, both in equities and bonds, Jerome Powell clearly pre-empted the Committee’s decision. On March 2, in front of the Finance Committee of the House of Representatives, he stated his desire to propose a 25bp hike to the Committee¹.

This decision is consistent with inflation which continues to rise and whose peak may not have been reached yet, the figures not yet reflecting the consequences of the invasion of the Russian armed forces in Ukraine. In February, the consumer price index (CPI) increased by 0.8% (0.6% in January). Over one year, it posted an acceleration of 7.9%, the largest since January 1982 (7.5% in January). The core CPI index, excluding energy and food products, rose by 0.5% (0.6% in January), and by 6.4% over one year. It marks the vigilance of the Federal Reserve in the face of second-round effects on both wages and product prices, while companies have gained significant pricing power, as highlighted in the latest Beige Book. It is also consistent with a labor market under strong tension, which suggests that the objective of full employment has been achieved, paving the way for a less accommodating monetary policy. Finally, it is for the Fed to react to tensions on inflation expectations. Inflation break-evens on 5Y Treasurys rose to 3.5% from 3% at the start of the year, while the 5Y5Y inflation swap is at 2.65%².

Jerome Powell should also stress his desire to remain agile, and to be ready to raise rates more aggressively if necessary, with increases of more than 0.25% in the event of stronger or more persistent inflation. The Fed went into emergency mode, as it missed windows in 2021, amid the health crisis continuing to blur visibility. Despite a context of high uncertainty regarding the consequences of the invasion of Ukraine, in terms of growth and inflation, the Fed is clearly returning to its fundamentals, price stability.

This rate hike should not surprise the markets, which are expecting 6 and 7 rate hikes in 2022. However, we are not entering a bullish cycle that might unfold over several years. Investors have understood that these were tactical hikes linked to the inflation slippage, since they have recently been anticipating rate cuts in 2024, in the face of a growing probability of the US economy entering recession. medium term.

After the European Central Bank’s speech on March 10, the Fed’s announcements mark a return to fundamentals for central banks. Faced with the price shock, which affects the most fragile and is also, it must be remembered, a destabilizing factor for democracies, the fight once morest inflation is considered by central banks as a guarantor of political stability.

² Bloomberg 11 mars 2022.