Inflation is too high and the labor market extremely tense. With these words, the Governor of the US Federal Reserve Jerome Powell opened a press conference after the May meeting of the Monetary Committee. The bank has further raised interest rates and will continue this process. At the same time, it announced the beginning of a reduction in the balance.
Although economic activity declined in the first quarter, the Fed points to strong household consumption and corporate investment. The labor market remains robust with strong job creation and low unemployment. According to the Fed, its tension is literally extreme. Inflation is then too high, due to imbalances in supply and demand, energy prices and wider price pressures.
The war in Ukraine was described as a factor of high uncertainty and higher inflationary pressures. According to the Fed, Covid closures in China will contribute to further supply chain disruptions. Both areas thus have a clear pro-inflationary effect.
In line with the goal of price stability and full employment, the Fed raised the key interest rate by 50 basis points to 0.75-1%. Further increases will follow in the next few sessions. According to Governor Powell, the Monetary Committee will do everything in its power to restore price stability.
In June, the bank will begin a process of reducing its balance sheet at a monthly rate of $ 47.5 billion, of which $ 30 billion for bonds and $ 17.5 billion for mortgage-backed securities. After three months, these values will increase to $ 60 billion for bonds and $ 35 billion for MBS.
According to Powell, the Fed expects an increase in participation rates and a slowdown in job creation. This should lead to higher unemployment, to which the Fed’s policy should also contribute. On this basis, wage growth should also slow down, but it is still likely to remain at relatively high levels. However, they should be consistent with inflation at the level of two percent.
In its monetary policy trade-off outlook, the Fed relies on high household savings and financially sound companies. The state of the labor market and the strength of the US economy should help a “smoother” landing. According to Powell, the world’s largest economy, thanks to its good condition, should raise rates without falling into recession. It will not be easy, but the bank will do everything to achieve this scenario, he said.
Asked if the Monetary Committee was considering a 75-point rate hike, Powell said no. According to the governor, there is a consensus that it will be appropriate to increase by another 50 points at future meetings. However, central bankers will decide according to the situation. However, if the committee sees what it expects to see, there will be several increases of half a percentage point on the table.
Powell also noted that the Monetary Committee will monitor the evolution of funding conditions and how they are affected by monetary policy. According to him, this will also affect how far rates move relative to the estimated neutral level. However, the governor acknowledged that a move above this value was likely. However, this is not a decision of the current moment. Incidentally, this outlook is in line with the current forecast, with the June one likely to show an even greater shift above “neutral” – at a median of 2.4%.
The reaction of the markets shows the disappointment that Governor Powell denied the prospect of a 75-point rate hike. This was reflected in particular in the weakening of the dollar against the euro, the fall in yields along the yield curve and the rise in shares. However, we assume that this is a temporary matter. Markets will tend to re-evaluate this step, especially if we see positive surprises for US labor market data and inflation. The outlook for US monetary policy this year will bring a shift to at least the aforementioned neutral rate. The reduction in the balance sheet should also have an impact on higher market rates, especially longer maturities. Although this scenario, Powell is very uncertain.
Therefore, at least in the short term, we continue to work on the risks to the stronger dollar due to US monetary policy and a possible deterioration in market sentiment due to the war in Ukraine and the negative sentiment towards the euro.
Source: Fed
–
