The Fed’s Policy is tightening – prepare for a bumpy ride ahead
On Wed 26th of Jan 2022 Jeremy Powell, the Chair of the Federal Reserve made some important announcements around guiding principles and influencing factors for rate hikes starting in March 2022 and a reduction of the Federal Reserve Balance Sheet.
Due to the high levels of inflation that have lasted longer than expected Jeremy Powell made it clear that rate hikes from March are likely on the cards, coupled with a hard stop to further bond-purchasing programmes.
The highly inflated Balance Sheet due to COVID-19 is likely to be tackled next, however, Powell was very clear that rate hikes and a stop to the buying programme would come first since that is the “primary means of adjusting the stance of monetary policy”. Powell was very firm that the sell-off of the Balance Sheet is something that will be done in a measured way with ample notice to prepare the market and with more details to follow that are yet to be fully worked out.
Why now?
Inflation has been at an almost 40-year high in the US hitting 7% in December 2021 and US employment has been down to 3.9%. High inflation has been of great concern to Congress and the Federal Reserve because it means that cost of living has been sky-rocketing to levels people may not be able to afford threatening overall price stability.
Powell was very confident that due to a very strong labour market a rate rise would be well absorbed by the economy, however, he did emphasise that there is much uncertainty at the moment that requires the Federal Reserve to remain “nimble so we can respond to the full range of plausible outcomes.”
How the markets reacted
The US stock market jumped slightly after the first announcements and then dropped slightly in response to Jeremy Powell’s interview with journalists on Wednesday afternoon. Since then European and Asian markets gained slightly whilst investors are still digesting the news for the coming weeks.
There is a lot of uncertainty on how well Federal Reserve monetary policy works to curb inflation given the Federal Reserve is moving on unfamiliar ground at the moment.
The Bank of England is expected to raise rates soon as well, whilst the People’s Bank of China is taking a very different approach. The European Central Bank is also under pressure since it has signalled to not raise rates until 2023.
Many are concerned that the hiking of rates could lead to a drastic economic downturn, or even a recession, coupled with a further increase in oil and gas prices.
Given the many unanswered questions, investors are wise to fasten their seatbelts for a bumpy ride ahead.