Is Fed policy in the eye of the beholder?

THE US Federal Reserve chair Jerome Powell delivered his much-anticipated speech, “Monetary Policy and Price Stability”, at the annual Jackson Hole symposium on Aug 26. In just 1,301 words, about one-third of the usual chair speeches and the shortest since the time of Alan Greenspan, Powell essentially indicated that bringing high US inflation down to the Fed’s 2 per cent target would require further interest rate increases and perhaps for rates to stay higher for longer once they had reached their peak. Markets reacted accordingly – that is, bond yields rose, more so for shorter maturities; credit yield spreads widened, equity prices fell, market-based inflation compensation declined, and the US dollar appreciated.

The latest message added to a series of deliberate “tightening shocks” that the Fed has delivered since it started reversing its ultra-easy policy stance implemented in the wake of the Covid-19 economic disruption in 2020, composed of the policy interest rate (the federal funds rate, or FFR) set near zero, forward guidance for it to remain so for several years, and a large bond purchase programme.

To briefly recap the tightening shocks, in December 2021 Powell shifted from the previous Fed view that elevated inflation was transitory, and in January 2022 the Fed announced an early end to bond purchases and indicated that raising the FFR would soon be appropriate. It increased the FFR by 25 basis points (bps) in the subsequent March meeting, upped the pace to 50 bps in May, and then to 75 bps for June and July (to the present range of 2.25-2.50 per cent). And Powell’s latest speech indicated that forthcoming data would determine whether a further 75 bps hike in the September Fed meeting would be delivered. Our calculations show that markets have already upped the chances from roughly 60 per cent to around 75 per cent (up till Aug 30). In addition, from June, the balance sheet has been reduced by US$47.5 billion a month, and the pace of reduction will be increased to US$95 billion from September.