Fed ready to raise rates and surf between inflation and recession

For the US central bank, the big moment has arrived: on Wednesday the institution is expected to raise its reference interest rates to fight inflation, two years after taking them to zero to help the economy facing COVID-19, and while the war in Ukraine creates new uncertainties.

The objective of the Fed is to pressure commercial banks to offer their clients higher interest rates for loans, in order to contain consumption and, therefore, alleviate the pressure on prices, especially since he expects the current supply chain problems to last for months.

With inflation at 7.9% 12 months in February, its highest level since 1982, the powerful US Federal Reserve (Fed), which holds its monetary policy meeting on Tuesday and Wednesday, wants to get moving.

The organization’s president, Jerome Powell, recently expressed confidence in the institution’s ability to ensure a “soft landing“, namely, “control inflation without causing a recession”.

However, the exercise promises to be delicate and the Fed will have to act strictly. “The combination of higher inflation and slower growth presents a dilemma for the Federal Reserve”, Wells Fargo bank economists said in a note.

They point out that the Fed will give priority to combating inflation, especially since the monetary institution “it has gained credibility in recent decades as a guardian of price stability.”

According to these experts, in 2022 there will be six increases in interest rates of a quarter of a percentage point (0.25%) each.

“proper” act

For the Joe Biden administration, the ball is now in the Fed’s court, with Treasury Secretary Janet Yellen, a former central bank chair, stating that it is “appropriate” that the organism acts.

Yellen told CNBC on Thursday that she, too, hopes “a soft landing”.

Since March 2020 the rates have ranged between 0 and 0.25%.

The Fed generally raises them by 0.25 percentage point each time, but for a while the possibility of a more abrupt 0.50 point hike seemed plausible.

However, Jerome Powell was very clear during a congressional hearing in early March: “I am inclined to propose and support a 0.25 basis point (benchmark interest) rate hike”.

In the markets, nobody expects a rise of half a point anymore. Nearly all players (95.9%) are betting on a quarter point, with the others even expecting rates to remain at their current level, according to a CME Group survey.

In Europe, where inflation is lower, the Fed’s counterpart, the ECB, decided on Thursday to keep rates at their current record lows.

The ghost of the 1970s

Inflation in the United States rose to 7.9% year-on-year in February, according to the Commerce Department’s CPI index, and the war in Ukraine caused a new spike in gasoline and food prices.

The Fed favors another indicator, the PCE index, which showed inflation of 6.1% year-on-year in January.

Price increases raise the specter of double-digit inflation as in the 1970s and early 1980s, a time when the Fed dramatically increased rates, up to 20%. The rise in prices slowed down, but the country fell into recession.

“The 1970s are etched in the institutional memory of the Fed”, underline the Wells Fargo economists.

The Fed is also expected to discuss soon when to start winding down its balance sheet — that is, gradually unwinding the billions of dollars in Treasuries and other assets it has bought since March 2020 — to support the functioning of the economy.