new York Jerome Powell has communicated his next steps with unusual clarity. The US Federal Reserve (Fed) intends to raise interest rates on Wednesday by 0.25 percentage points, as the Fed chief signaled in a hearing before the US Congress in early March. At the time, the war in Ukraine was just beginning, but most economists assume Powell wants to stay the course. The central bank does not want to cause any surprises unnecessarily.
It will be the first rate hike since 2018. All twelve heads of the regional central banks and the four governors are expected in person in Washington – for the first time since the pandemic began a good two years ago. It’s the toughest assignment of Powell’s career as Fed chairman.
Even in times of stability, it is a challenge for monetary policymakers to gradually raise interest rates after a period of zero interest rates without jeopardizing economic growth too much. Rapidly rising inflation and the uncertainties surrounding the Ukraine war only complicate this mission.
In addition, Powell has been under criticism for a long time. He “is much too late”, complains capital market expert Mohamed El-Erian, who advises Allianz, among others, “so he no longer has any good options”. Politicians are also upset because their voters complain about high prices – especially those at the gas station.
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Powell could hike rates significantly and risk sending the US economy into a deep recession – much like what then Fed Chairman Paul Volcker did in the 1980s. However, this option is considered unlikely. Lower- and middle-income Americans would be doubly affected in the downturn — rising unemployment and rising prices.
Dangerous wage-price spiral
A more cautious approach to inflation is more likely – but comes with its own risks. The independent US economist Ed Yardeni warns of a “dangerous wage-price spiral”. Because inflation expectations are no longer as firmly anchored as the Fed would like them to be. “Consumers now expect inflation to be 6 percent in three months and 3.8 percent in 12 months,” he said, citing data from the New York Fed. Before the pandemic, both values were around 2.5 percent.
Economists and investors are preparing for a phase of further rising prices and low growth. Goldman Sachs economists have lowered their growth expectations for the US from 2 to 1.75 percent this year. The risk of recession is 20 to 35 percent – so there is a risk of stagflation.
El-Erian believes that inflation could rise to a good 10 percent in the summer before slowly falling again. In February it was 7.9 percent – the highest it has been in 40 years. Treasury Secretary Janet Yellen also had to concede that prices are likely to remain “uncomfortably high” for a whole year.
Even before Russia’s invasion of Ukraine, Powell had bailed markets on a move away from ultra-loose monetary policy. Rapidly rising costs of energy and raw materials are now making a number of goods even more expensive to produce and transport. There are also new Covid outbreaks in China, which are causing further problems in the supply chains.
Seven rate hikes this year?
The US Federal Reserve is aiming for an inflation rate of around two percent. The economic projections of the central bankers, called dot plots, which will also be published on Wednesday, are also important for investors. They provide information on the forecasts made by monetary policymakers with regard to interest rates, unemployment and economic growth up to the end of 2024.
Goldman’s chief economist Jan Hatzius expects seven interest rate hikes of 0.25 percentage points this year and four more in 2023. Market observers believe that an increase of half a percentage point is also conceivable if the pressure on the economy does not become too great.
A number of central bankers have recently spoken out in favor of a much tighter course. James Bullard, head of the regional Fed in St. Louis, recently called for a “rapid departure from loose monetary policy”.
Fed Governor Michelle Bowman spoke of “significant steps” that the central bank would have to take to bring inflation back to the target of two percent. Fed Governor Christopher Waller wants interest rates to be at least 1 percent this summer – they are currently zero.
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