Frankfurt On Saturday, the famous US investor Warren Buffett found remarkable words at the annual general meeting of his holding company Berkshire Hathaway: “In my opinion, Jay Powell is a hero. He did what he had to do.” The comment about Jerome Powell, the head of the US Federal Reserve (Fed), referred to his efforts to combat the corona pandemic, which has helped the US economy recover quickly.
But is Powell a hero? In view of the recently high inflation rate of 8.5 percent, this is hardly mentioned anymore. The Fed will increase the pace of its monetary tightening this week. It is almost certain that it will raise the key interest rate by half a percentage point. It’s also likely to officially start shrinking its balance sheet.
Fed expert Michael Feroli of the US bank JP Morgan expects the key interest rate to be raised to a range of 0.75 to 1.0 percent, after previously 0.25 to 0.5 percent. That would then be the second rate hike in a row and, after an increase of a quarter of a percentage point, a movement of half a percentage point for the first time.
James Bullard, head of the St. Louis regional Fed and a member of the monetary policy committee, had already advocated a larger interest rate hike of half a percentage point in March. Feroli writes that one or two committee members might even push for a 0.75 percentage point move on Wednesday. From now on, Deutsche Bank expects three steps of half a percentage point in a row and an interest rate of 3.6 percent as a target.
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Feroli also predicts that the Fed will cap asset purchases going forward, at $60 billion a month for government securities and $35 billion for securitized home loans. These numbers were already shown as a broad consensus in the March meeting minutes. Feroli suspects that the cap will initially be put in place for three months. Limiting purchases means not all maturing paper will be replaced, so total assets will decrease over time.
Fed wants to get rid of securitized loans faster
At the March meeting of the central bank, it was already discussed whether the securitized loans should be sold off a little faster. The Fed would then only own government securities. Feroli suspects that the official start of the balance sheet reduction will be in June. Deutsche Bank expects a start in May and estimates that total assets would fall by $1.6 trillion by the end of 2023. It is currently around 8.9 trillion, after actually falling slightly recently.
Ellen Gaske, senior economist at the US fund company PGIM, has similar expectations to those at JP Morgan and Deutsche Bank. She recommends paying particular attention to two questions at the press conference on Wednesday evening German time.
- First: How quickly does the Fed want to reach a neutral interest rate level, i.e. one that neither boosts nor slows down the economy? Gaske notes that the height of this neutral level, which cannot be measured directly, is quite controversial.
- The second question: How will Fed Chair Jerome (aka “Jay”) Powell comment on the trade-off between fighting inflation and avoiding a recession? Most recently, she notes, he downplayed economic risks and emphasized fighting inflation. In fact, concerns have increased significantly recently that the central bank could choke off the economic recovery after the corona pandemic.
Unlike the European Central Bank (ECB) and many other central banks, the Fed expressly has full employment as its second goal alongside price stability. However, the job market is still overheating; also because some Americans have not yet gone back to looking for a job after the corona pandemic.
The key interest rate primarily affects short-term yields. Bond purchases have kept long-term interest rates low in recent years, but this tends to be reversed with the reduction in total assets. It is disputed how far the capital markets have already anticipated the change in monetary policy.
Yields on 5-, 10- and 30-year US government bonds were all between a good 2.9 and just under 3.0 percent on Monday. Higher yields automatically mean lower bond prices, and the surge in bond prices over the past few months has already put significant pressure on stock prices, particularly those of very highly rated companies.
pressure on share prices
The Fed initially classified the high inflation as “temporary” last year. Because the values have continued to rise, she has received harsh criticism and has since dispensed with this vocabulary.
At 8.5 percent, inflation in the USA is not just one percentage point higher than in the euro zone. It is also spread even more widely across all possible areas of the economy. In addition, the labor market is already part of the inflation process much more clearly than in Europe.
Diane Swonk, chief economist at the US consulting firm Grant Thorntons, also sees the latest quarterly results in connection with the price increase. “The need to address inflation became even clearer with last week’s earnings reports,” she writes. “Even the biggest tech companies are feeling the impact of higher costs and supply shortages.”
In addition, the burden of higher prices has also clouded the business of online retailers. In the past week, companies such as Alphabet (Google), Microsoft, Apple and Amazon announced figures, some of which were acknowledged with significant price losses.
More: Fed Chair Powell prepares markets for May’s major rate hike