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Doc’s Prescription: Federal Reserve plans faster interest rate increases
By Ernest ‘Doc’ Werlin,
On March 7, Chairman of the Federal Reserve Jerome Powell indicated that he was prepared to raise interest rates by 50 basis points later this month (March 22) in order to cool the economy that has shown surprising strength.
In his testimony before the Senate Banking Committee, Powell said, “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
Morgan Stanley economists said that Powell opened the door to raising rates by a half a percentage point. They wrote, “Chair Powell’s assessment of the economic outlook acknowledged that higher rates are impacting interest-sensitive components of the economy, including housing, but that there has been a concerning reacceleration in activity in January, partly reversing the softening trends that we had seen in the data just a month ago.”
Analysts believe that Mr. Powell’s comments reflected declining confidence in our central bank’s ability to bring down inflation to its 2% goal over the next few years without causing a recession.
Why will the Fed change policy?
The personal-consumption expenditure price index (PCE), the Fed’s favorite inflation measure, has revved up again. PCE rose .6% in January, the highest since June.
In 30 days, the position of the Fed has changed dramatically. In early February, central bank officials felt that moving in smaller steps would better allow them to assess the effects of last year’s rapid increases and reduce the risk of raising rates too much.
During the pandemic, the Federal Reserve held down rates to near zero. Subsequently, the Fed has lifted the rate more over the last 12 months than any time since the early 1980’s.
In February, the Fed increased the benchmark federal-funds rate by only 25 basis points to a range between 4.5% and 4.75%; followed increases of .50 basis points in December and .75 basis points in November and at three previous meetings.
Mohamed El-Erian commented on CNBC: “The Federal Reserve flip-flopping on monetary policy is threatening to send the U.S. economy into a recession … much of the economic anxiety can be laid at the feet of the Fed officials, who he said should have held to their more aggressive hikes rather than the 25-basis point increase approved on Feb. 1.”
The Fed has been taking steps to slow investment, spending, and hiring to combat inflation by raising rates. Higher rates historically have pushed down the price of assets such as stocks and real estate.
The government stimulus measures implemented during the pandemic have left households and business finances in strong shape. Companies are still dealing with shortages of materials and workers.
Economists expected that, on March 10, the Labor Department would report that we had added 225,000 jobs for February. Instead, payrolls rose 311,000, more than expected, showing solid growth. Morgan Stanley economists said, “Upside surprises to Friday’s payroll report could drive a faster and longer tightening cycle.”
There are precedents for the Federal Reserve manufacturing a recession to bring prices down. In the 1980s, overnight rates rose above 20% to break the back of our inflation that was running at an annual rate of 14.6%.
A Wall Street editorial, “Full Steam Ahead for Jerome Powell,” pointed out that “monetary policy works with long and variable lags.” The editorial stated that “team transitory was wrong that inflation would not persist, and it may now be wrong in declaring that it has been vanquished. Mr. Powell’s job is to keep going until the inflation beast is dead for sure, and right now it does not even look mostly dead.”
Sarasota resident Ernest “Doc” Werlin spent 35 years in fixed income as a trader and corporate bond salesman, including time as a partner at MorganStanley in charge of corporate bond trading. Send suggestions and comments to firstname.lastname@example.org or visit docwerlin.com.