Juan Pedro Marín-Arrese | The hawkish and straightforward message Jerome Powell delivered yesterday surprised analysts and markets alike. They expected a non-committal press conference following a routine FOMC meeting. Instead, Powell unfolded the planned roadmap for monetary tightening. He even announced a rate hike in March, breaking the rule of refraining from providing precise tips on future action, coupled with a sharper than expected increase in federal funds rates. It came as a shock to observers who were betting the Fed’s increases would be in gradual steps of around 25pb.
Powell also underlined monetary policy would rest on rate management, cutting short any speculation on stout action to shrink the massive 9 trillion balance sheet. The Fed will only abandon its current practice of reinvesting securities coming to maturity in its portfolio, thus ensuring a soft landing for Treasury bonds.
As analysts and even the White House blamed his dilettante mood in tackling price rises, Powell was under heavy pressure. Yet, until a couple of weeks ago, the yield curve failed to show any evidence capital markets were discounting any entrenched inflationary outlook. Pretending things would come to normal on their own was no longer tenable. The Fed had to address the extreme volatility striking financial markets. It has retaken the initiative by delivering an unambiguous message on its firm commitment to act swiftly and forcefully.
Yesterday, Powell scored a full hit by setting the stage for a full-bodied tightening. Will he honour such promises? Much will depend on how prices behave in the coming months. Should they start abating by mid-summer, the rate hikes might not go beyond a relatively meek level. As he stressed, the current gap between interest rates in the US and those prevailing in Europe leaves little room for further increases. Otherwise, the flight to the dollar might trigger widespread global instability, as Janet Yellen witnessed a few years ago.
While Powell trumpets his adamant will to make war on inflation until it is beaten, his field campaign might end up in mere skirmishes. He’s fully conscious that crossing red lines on yields would endanger US debt sustainability. A threat the Fed cannot ignore or dismiss.