Federal Reserve Chairman Jerome Powell has finally acknowledged that monetary tightening needs to go “a little more quickly,” telling an audience at the International Monetary Fund last week that a half-point increase in the Fed rate “will be on the table” at the policy meeting May 3-4.
Moreover, Powell confirmed market expectations that a more aggressive series of rate increases is also on the table. Analysts now expect the overnight fed funds rate to be somewhere between 2.75% and 3% by the end of the year instead of the 1.9% policymakers forecast at the March meeting of the Federal Open Market Committee.
Deutsche Bank, for one, has predicted that the rapid rate increases, combined with a quick run-off of the Fed’s bond portfolio, will plunge the US economy into recession next year.
Bank economists David Folkerts-Landau and Peter Hooper have forecast a policy rate peaking at 3.5% in the middle of next year while they expect the Fed to trim $2 trillion from its $8.9 trillion balance sheet by the end of 2023, equivalent to another three or four quarter-point hikes.
The Deutsche Bank experts are more pessimistic than other economists, but they are confident others will come to share their view.
At the same time, there seems to be little support on the FOMC for a 75-basis-point hike suggested as a possibility by super-hawk James Bullard, head of the St. Louis Fed.
His counterpart at the Cleveland Fed, Loretta Mester, downplayed the notion on CNBC last week.
“Doing one outsized move in the funds rate doesn’t appear to me to be the right way to go. I would rather be more deliberative and more consistent.”
Chicago Fed chief Charles Evans similarly dismissed anything more than a half-point increase earlier in the week.
But portfolio managers at Osterweis Capital Management expressed skepticism that Fed policymakers would be able to pull off a soft landing—taming inflation while avoiding a recession as they raise rates and allow shorter-dated bonds to mature without replacing them.
In a report on the second quarter outlook for total return that faults the central bank for not selling off longer-dated bonds, they stated:
“Sadly, implementation of a dual-pronged quantitative tightening plan requires a level of finesse that the Fed is not known for.”
Fed policymakers love to talk about reaching the “neutral” rate, which neither stimulates nor hinders economic growth. The problem is no one really knows just what that neutral rate is and high inflation makes determining it more challenging than ever.
Many believe you can only identify the neutral rate in retrospect, so it’s not particularly useful as a policy guide.
ECB Rift On Policy Direction Widens
At the European Central Bank, meanwhile, there is a growing rift between the hawks wanting earlier monetary tightening and the doves wanting to maintain accommodation.
The rift has grown wide enough that ECB President Christine Lagarde asked members of the governing council at the meeting earlier this month to hold off on critical remarks immediately after the meeting.
Lagarde, who had no previous experience in monetary policy, has been political in her ECB role, preferring to err on the dovish side.
Her name has even been floated as a possible choice for French prime minister when the just reelected President, Emmanuel Macron, appoints a new government for the parliamentary election campaign in June.
ECB hawks want to see the first rate hike at the July meeting of the governing council, once the central bank has terminated its bond purchase program.
Even the centrist vice president of the ECB, Luis de Guindos, has suggested July is a possibility both for ending bond purchases and raising rates.
For De Guindos, a former economy minister in Spain, he said in an interview that the key to policy is the outlook for inflation.
“If we start to observe a de-anchoring of inflation expectations and second-round effects, then this is going to be a key element for the future of monetary policy.”