Analysis: Powell’s Messaging Binds Fed To 25bps When Need is For 50bps
- Published on
- 15 Mar 2022, 08:48 AM
(This Analysis was first published on Friday, March 11 at 5:38 PM as an email to premium subscribers)
By Sophia Rodrigues
(March 11, 2022)—There is no doubt that central bank communication plays a big role in guiding market expectations but there is a fine line between communicating too much and too clearly, and not communicating enough.
The risk with the former is that it doesn’t leave any room for last-minute manoeuvre should conditions change because a central bank has already communicated a clear plan. The risk with the latter is the decision would be a surprise to market and it could lead to volatility.
Federal Reserve Chair Jerome Powell is using the former approach and seems pleased that the Fed has taken big decisions in the last six months without causing any volatility in the market.
His thoughts are summed up in this statement from the minutes of January meeting.
“In their discussion of the outlook for monetary policy, many participants noted the influence on financial conditions of the Committee's recent communications and viewed these communications as helpful in shifting private-sector expectations regarding the policy outlook into better alignment with the Committee's assessment of appropriate policy.”
Powell is not wrong except that in each of the recent instances, the Fed didn’t opt for the "right" decision at the time simply because it had not telegraphed it earlier.
History will judge the cost of every such delay.
For Powell, surprising the market wasn’t an option, so he might have compromised on the right decision.
The pattern will be repeated at the upcoming March meeting where conditions probably justify 50-basis-points hike but the Fed will likely do just 25bps because Powell has already sent that signal.
Earlier this month, market had started doubting if the Fed would hike in March because of the Ukraine war, but Powell stepped in to convey a hike remained on the table.
He took a cautious approach to avoid rattling the market and pointed to possibility of just 25bps, thus extinguishing any option for 50bps.
Any action other than 25bps hike now would cause a lot of market volatility, so the Fed will likely stick to a hawkish 25bps hike by signalling the next move in May could be 50bps.
It will be interesting to see whether 25bps hike is unanimous or with some dissent. The latter is more likely, with at least a couple of votes likely to be in favor of 50bps.
Powell’s speech at the Jackson Hole in late August was the first time he raised the point that central banks cannot take for granted that inflation due to transitory factors will fade, and he highlighted the importance of monitoring inflation expectations.
By September meeting, Powell was convinced that high inflation was not as transitory as he previously thought. In that sense, September meeting was the turning point for the Fed as Powell later admitted. Ideally it should have marked the start of tapering of asset purchases.
Instead, the Fed opted to signal asset purchases might be announced as early as the next meeting.
By November meeting, concerns on inflation had risen further. The Fed announced tapering but instead of announcing a faster taper, it stuck to the plan it had telegraphed a month before even though economic conditions had clearly changed.
In December, as inflation worries increased further, there was a case to end asset purchases immediately, but the Fed chose to double the pace, so it doesn’t surprise the market.
“We’ve learned that, in dealing with balance sheet issues, we’ve learned that it’s best to take a careful sort of methodical approach to make adjustments. Markets can be sensitive to it,” Powell said in December.
In January it was very clear the Fed was dealing with elevated inflation that would linger for longer and policy needed to tighten. But it stuck with its asset purchase plan and sent a tightening signal through the message that rate hike could happen as early as March.
As the Fed goes into its March meeting, inflation has risen still further and there is now doubt if it will decline over the course of this year as previously expected.
“We are attentive to the risks of potential further upward pressure on inflation expectations and inflation itself from a number of factors,” Powell said in his March 2 statement.
While actual inflation is a worry, the bigger concern is rise in inflation expectations. According to Bloomberg, “the so-called 10-year breakeven rate, derived from the difference between conventional and inflation-adjusted Treasury yields, rose to as much as 2.785%, surpassing the previous high reached in 2005.”
Since Powell’s testimony and now, rise in global commodity prices and supply chain disruptions, along with recent data, all call for Fed to act to dampen inflation expectations. The appropriate course would likely be 50bps but expect the Fed to stick to 25bps.
All because Powell left no room for manoeuvre.