All week, Wall Street waited with bated breath for the Federal Reserve Open Markets Committee to emerge from its two-day policy meeting and signal where monetary policy will be heading in the coming months. The suspense over the impending, vaguely worded summary of the central bank’s intentions sent markets swinging madly between bouts of panic selling and exuberant rebound rallies.
Which, on one level, is a bit strange.
The Fed does not like surprising investors. It goes out of its way to foreshadow policy changes and implement them gradually. Before this week, the minutes from the Fed’s December meeting had led observers to believe that it would raise its benchmark interest rate by about o.25 percent at its meeting in March, and make two to three subsequent rate increases later in the year. Analysts also expected the Fed to begin removing Treasury bonds and mortgage-backed securities from its balance sheet once rates started to rise, a move that would effectively put further upward pressure on interest rates.
“With inflation well above 2 percent and a strong labor market, the committee expects it will soon be appropriate to raise the target range for the federal funds rate,” the central bank said in its Wednesday statement, adding that balance-sheet reduction “will commence after the process of increasing the target range for the federal funds rate has begun.”
In other words: Before Wednesday, the Fed had given investors a signal — but no explicit promise — that interest rates would begin rising in March, and that the central bank’s balance sheet would begin shrinking sometime thereafter. On Wednesday, the Fed … gave investors a signal (but no explicit promise) that it would do precisely this. Which was what markets expected it to do.
This is what qualifies as a blockbuster-news event on the monetary-policy beat (Bloomberg’s cable channel actually held a The NFL Today–style countdown show leading up to the Fed statement’s release).
Anyhow, once the central bank’s statement was published, attention turned to Jerome Powell’s press conference — typically, a bizarre ritual at which reporters try to get the Fed chair to commit some Freudian slip that gives markets more clarity about his thinking than he wishes them to have, while Powell struggles to answer their questions without actually doing so, and investors explicate his every word for subterranean significance like a pack of English majors hopped up on semiotics and Adderall.
On this occasion, though, Powell’s remarks proved both more specific — and, at least in the view of some analysts, more hawkish — than the statement that preceded him.
The Fed chair told reporters that “the committee is of a mind to raise the Fed funds rate at the March meeting” — if conditions merit such an action. That might seem like a tautology. But his implication was that, barring a significant change in economic circumstances, a March rate hike is a go. More significant than this confirmation of the central bank’s previously implicit thinking was Powell’s refusal to rule out a .50 percentage-point hike in March. Indeed, when asked about that prospect of such an increase, the Fed chair noted the tightness of the current labor market, as measured by the ratio of job openings to unemployed workers.
Powell further revealed that his own forecast for core inflation in the coming months is now “a few tenths” higher than it was in December, a disclosure that further reinforced the impression that the Fed’s appetite for rate hikes may be higher than anticipated. Following the release of the Fed’s statement, the Dow Jones Industrial Average briefly jumped 400 points; following Powell’s press conference, it gave up this gain and turned slightly negative on the day.
If Powell’s remarks were mildly unfavorable for stock values, their implications for the median American are less certain. The Federal Reserve has a dual mandate to promote full employment and price stability. These objectives are generally considered to be in some tension. Making credit cheaper will encourage spending and investment, thereby increasing employment opportunities and inflation. Making it more expensive will discourage all three, thereby reducing price pressures at a cost to job creation.
In recent years, the central bank began taking the “full employment” part of that mandate more seriously; instead of attempting to preempt high inflation when the unemployment rate threatened to fall “too low,” the Fed embraced a more dovish approach to monetary management, one that reflected its persistent failure to hit its target of 2 percent inflation. As recently as September, there was some disagreement among Fed governors about whether any rate hikes would be necessary in 2022. For most of last year, the Fed’s analysis held that inflation was rooted in temporary supply-chain bottlenecks and would therefore prove “transitory.”
Since then, however, the consumer-price index has risen at an accelerating rate, while inflation has made itself felt in a broader range of economic sectors. In December, inflation rose at a 7 percent annual rate, the fastest increase America had seen in four decades. Meanwhile, the unemployment rate fell to 3.9 percent. In opinion polls, voters say that inflation is their top concern. And the Fed has adopted similar priorities.
Nevertheless, on Wednesday, Powell insisted that taming inflation need not necessarily come at the labor market’s cost. Specifically, the Fed chair said that he saw “plenty of room to raise rates” without adversely affecting the labor market — the logic of his claim apparently being that small rate hikes will have a big enough impact on economic activity to moderate prices, while slowing job gains without reversing them. To the extent this is the case, monetary tightening may yield higher average employment over medium-term, as curbing price growth will render the economic expansion more durable.
Powell attributed much of the present inflation to supply-side bottlenecks in his remarks. But he also suggested that the United States is currently near “maximum employment” — which is to say, if the labor market gets significantly tighter, employers will be forced to offer wage levels that can only be sustained through sharp price increases. Still, Powell emphasized that he believes that the economy may be able to sustain a higher level of “maximum employment” as the pandemic eases. At present, millions of workers who left the labor force during the COVID-19 crisis still have not returned. Such workers are not classified as “unemployed” since they are not looking for jobs. In many cases, these workers have withdrawn from the economy for COVID-specific reasons, such as concern for their health or heightened caregiving responsibilities. Once the Omicron wave has passed, it is possible that these workers will rejoin the workforce and that there will be more room for payrolls to expand without significant price rises.
In the immediate term, however, interest-rate hikes will make debt-financed investment and consumption more expensive. That should slow the rate of job growth and, theoretically, inflation, at the margin. Although there are some reasons to question how much impact very small increases in benchmark interest rates will have on either.
