[FOMC] US Interest Rate Expected at 1.9% by Year-End... Powell "Will Do Whatever It Takes to Curb Inflation"

[Image source=Reuters Yonhap News]

[Asia Economy New York=Special Correspondent Seulgina Cho] The era of 'zero interest rates' in the United States, which has continued since the COVID-19 pandemic, has come to an end. The message from the U.S. Federal Reserve (Fed), which hinted at the possibility of raising interest rates further at each of the remaining six meetings this year along with the decision to raise the benchmark interest rate, clearly indicates that we have now entered an 'era of tightening.' Jerome Powell, the Fed Chair's hawkish remarks that he will do "whatever it takes" to curb soaring inflation are no different.

◆Indication of 6 Additional Rate Hikes... Hawkish Message

On the 16th (local time), the Federal Open Market Committee (FOMC) decision to raise the interest rate by 0.25 percentage points was already anticipated by the market. This was because U.S. inflation reached its highest level in 40 years, increasing the need for normalization of monetary policy, and Fed Chair Powell unusually mentioned the possibility of a rate hike in March, so no surprises were expected.

Among the nine voting members of the FOMC, eight supported this rate hike. Even the one dissenting member did not advocate for a freeze. James Bullard, President of the Federal Reserve Bank of St. Louis and a representative hawk within the Fed, argued for a 'big step' of a 0.5 percentage point increase.

However, the Fed's projection of the year-end interest rate at 1.9% on the dot plot is considered more hawkish than expected. This number is only possible if a 0.25 percentage point increase is implemented at each of the six remaining meetings starting with the March FOMC. This is a significant upward revision compared to the December dot plot, which projected three rate hikes in 2022.

Additionally, the Fed's policy rate projection of 2.8% for 2023-2024 exceeding the long-term equilibrium rate of 2.4% is also hawkish. Morgan Stanley evaluated, "The policy statement met expectations, but the dot plot is very hawkish," adding, "The members have a strong will to stabilize inflation through early rate hikes."

Chair Powell also did not hide his concerns throughout the press conference, stating that inflation is more severe than initially expected. He said, "If it had been before Russia invaded Ukraine, I would have said inflation would peak at the end of the first quarter this year and then decline," adding, "We are seeing short-term inflationary pressures due to rising oil prices." Regarding the possibility of a big step, he responded, "I will decide based on the inflation outlook."

Mark Kanaba, Head of U.S. Short-Term Interest Rate Strategy at Bank of America (BoA), analyzed this dot plot as "a willingness to sacrifice some economic growth to curb inflation." The Fed also raised its forecast for the increase in U.S. Personal Consumption Expenditures (PCE) inflation to 4.3% this year, while lowering the real Gross Domestic Product (GDP) forecast by 1.2 percentage points to 2.8%.

◇Possibility of Quantitative Tightening in May Also Indicated

The timing of quantitative tightening (QT), the third step following tapering (asset purchase reduction) and rate hikes, has also been specified. The FOMC policy statement added forward guidance indicating that "it is expected to begin reducing holdings of Treasury securities, agency debt, and mortgage-backed securities (MBS) at upcoming meetings." Chair Powell also mentioned at the press conference that it could be "as early as the next (May) meeting." The minutes of the March FOMC meeting, to be released in three weeks, are expected to provide more detailed insights into the Fed's balance sheet reduction discussions. Powell also forecasted that the pace of QT would be much more aggressive than during 2017-2019.

The Fed's assets, which were $4.1 trillion in January 2020, have nearly reached a record high of $9 trillion due to bond purchases to supply liquidity during the COVID-19 pandemic. Wall Street experts view that reducing the Fed's assets by $500 billion has an effect similar to raising interest rates by 0.25 percentage points. Goldman Sachs expects that "specific details will be announced in May, but there is also a possibility of earlier disclosure."

◇Powell: "U.S. Economy is Strong... Low Possibility of Recession"

At the press conference, Chair Powell repeatedly expressed concerns about inflation but emphasized the strength of the U.S. economy's fundamentals and that the possibility of a recession has not significantly increased.

The stock market rebounded, focusing on confidence in the U.S. economy and the resolution of FOMC uncertainties rather than the anticipated tightening. Mike Lowengart, Executive Director of Investment Strategy at E*TRADE, said, "Don't forget that monetary tightening means the Fed believes the economic fundamentals are solid. This is ultimately a good thing," adding, "The market is smoothly absorbing today's news."