Unsurprisingly, the Fed is expected to announce a 50bp rate hike as well as the reduction in the size of its balance sheet from June.
Despite constant surprises on rising inflation over the past year, the US Federal Reserve has so far shown no sense of urgency: asset purchases were only halted last March, and this It was only at its last meeting that the Fed initiated a first and modest inflection of Fed Funds rates with a 25bp hike.
However, the latest inflation figures published for the month of March have again reached new highs, with a consumer price index (CPI) at +8.5% in March against +2.6% just 1 year. This publication reinforced the perception that the Fed had lagged in the normalization of its monetary policy.
It is therefore time for the Fed to act quickly and forcefully by trying to make up for lost time.
After the mea culpa of Jerome Powell, who admitted that the Fed should have acted sooner, it is a return to fundamentals for the members of the Monetary Policy Committee (Federal Open Market Committee – FOMC), with price stability as absolute goal. Their most recent and resolutely hawkish comments leave no doubt about the next meeting on May 3 and 4: the Fed should announce a 50bp rate hike as well as the reduction in the size of its balance sheet from the month of June.
The challenge in executing the normalization of its monetary policy will however be to ensure a soft landing for the American economy, while maintaining a dynamic labor market, and above all avoiding causing an entry into recession.
The -1.4% annualized contraction in US GDP in the first quarter should be taken with a grain of salt: it reflects an increase in imports and a drop in exports, while household consumption is still robust, at +2.7%. on an annualized basis in the first quarter. However, these figures illustrate the difficulty of the situation for the Fed, which is still faced with high inflation while the probability of the US economy entering recession over a horizon of 12 to 18 months has increased.
In this trade-off between achieving its price stability objective and the potential risk of a sharp slowdown, it seems unlikely to us that the Fed will sacrifice US growth… and that is what the markets are betting on at the moment: so that expectations on short-term rates have recently been adjusted to reflect this desire to raise rates very quickly with rises of 50bp priced over the next 3 meetings, it is interesting to note medium- and long-term inflation expectations are maintained at high levels, well above the 2% target (on 04/28, inflation break-evens on 5Y Treasurys were at 3.4%, and 2.9% for 10Ys) . For the markets, the price stability objective of 2% is not realistic without plunging the American economy into recession.
This pragmatic approach, according to which the Fed would stop its rate hikes to avoid weighing too negatively on activity, nevertheless remains a fragile scenario. The high degree of uncertainty about future inflation shocks, linked in particular to the rise in commodity and energy prices, makes forecasting difficult and should maintain high volatility on the interest rate markets.
In his press conference, Jerome Powell should not contradict market expectations, while insisting on the flexibility required to achieve the objective of price stability.