May 4, 2022 - Economy

The Fed gets serious about tighter money

Federal Reserve Chair Jerome Powell

Big day for Fed chair Jerome Powell. Photo: Yasin Ozturk/Getty Images

The Federal Reserve's policy announcement this afternoon will feel like something new. It will include the first in-person news conference in more than two years, and take place in a newly renovated building in Washington's Foggy Bottom neighborhood.

  • But the biggest change is that the Fed, after a methodical six-month buildup, is now going to get aggressive in its monetary tightening campaign, likely with a half-percentage point rate increase and the commencement of shrinking its balance sheet.

Why it matters: We know what the Fed is going to do today. The news will be in what signals chair Jerome Powell sends about just how much further he and his colleagues are willing to go if inflation doesn't start to come down.

State of play: For all the chatter about recession risk that has emerged from Wall Street commentators and corporate executives in recent weeks, most indicators point to an economy that is still robust.

  • The number of new claims for jobless benefits has remained at rock-bottom levels in recent weeks — and new numbers out Tuesday showed record levels of job openings and people voluntarily quitting their jobs.
  • Surveys of business conditions, like the Institute for Supply Management manufacturing index, show an economy that isn't roaring ahead as quickly as it was last year but still remains firmly in expansion territory.

Meanwhile, financial markets are doing the Fed's work for it — which is to say, tightening credit conditions in ways that should slow spending and help bring inflation down.

  • The yield on ten-year inflation-protected bonds — a measure of the real cost of borrowing — has risen from -0.92% in early November, when the Fed began its pivot toward tighter money, to 0.13% Tuesday.

In effect, the Fed has succeeded in re-setting expectations for policy without creating excessive distress in financial markets or causing a major economic slowdown.

  • As recently as September, the median Fed official envisioned only raising rates by a quarter-percentage point in all of 2022. Now markets are pricing in rate increases totaling 2.7 percentage points by the end of the year.

The big question: Is that going to be enough to actually subdue the inflationary forces that show signs of becoming entrenched in the economy?

  • Powell's steady approach has been successful at avoiding any major problems for the economy, but it's less clear whether it will get the job done on stabilizing prices.

What to watch: Powell is likely to face questions around the Fed's willingness to consider yet more aggressive actions — such as raising rates 0.75% at a time and well above levels now forecast — if inflation fails to come down in the months ahead.

  • He also has an opportunity to signal that the "Fed put" is no longer in place. That is to say, that the Fed will be disinclined back off from its tightening plans even if markets start to go haywire.

The bottom line: Powell has succeeded at turning the slow-moving ship of the Federal Reserve toward tightening — but the question hanging over Wednesday's press conference is how set the ship's course has now become.

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