[Summary] Fed No. 2 with Hawkish Remarks: "More Aggressive Tightening, QT in May"

[Image source=Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina] Lael Brainard, nominated as Vice Chair of the U.S. Federal Reserve (Fed), delivered a series of hawkish remarks. She announced plans to raise interest rates faster and more aggressively to combat inflation soaring to the highest level in 40 years in the U.S., and indicated that quantitative tightening (QT), including balance sheet reduction, could begin as early as next month. As Brainard, a leading dove (favoring monetary easing) within the Fed, joined the hawkish camp, global financial markets were shaken.

◇ Emphasis on "Aggressive Tightening"

In a speech at the Minneapolis Federal Reserve Bank on the 5th (local time), Brainard stated, "Lowering inflation is the top priority of policy." She explained, "We will begin rapidly reducing the balance sheet as early as the May Federal Open Market Committee (FOMC) meeting and continue tightening monetary policy by raising interest rates consecutively."

Brainard particularly emphasized "swift tightening" during this process. While agreeing with fellow board members who expect seven rate hikes (each by 0.25 percentage points) within the year, she confirmed that stronger actions could be taken depending on inflation pressures. This suggests that the frequency of big steps?raising rates by 0.5 percentage points at once?may increase. Market observers predict at least two big steps will be implemented this year.

She also indicated the timing for entering quantitative tightening, the third stage following tapering (asset purchase reduction) and rate hikes. The May FOMC meeting, which Brainard mentioned as the start of balance sheet reduction, aligns with the timeline previously announced by Fed Chair Jerome Powell.

She said, "Considering that the recovery is much stronger and faster compared to previous cycles, we will reduce the balance sheet faster than during 2017-2019, the last tightening period." The Fed's assets, which stood at $4.1 trillion in January 2020 before the pandemic, now approach a record high of $9 trillion. Wall Street experts view a $500 billion reduction in Fed assets as having a similar effect to a 0.25 percentage point rate hike.

◇ Hawkish Signals to the Market... Sharp Rise in Treasury Yields

The hawkish message from the Fed came a day before the release of the March FOMC minutes. Since Brainard’s remarks were based on a prepared script rather than impromptu comments, analysts suggest that prior coordination within the Fed was made to send a clear signal to the market. The minutes to be released on the 6th are expected to contain specific details indicating the pace and scope of the Fed’s tightening.

Esther George, President of the Kansas City Fed, also supported the possibility of a 0.5 percentage point hike in an interview with Bloomberg TV on the same day. She emphasized, "Discussions on rate hikes should be conducted alongside balance sheet reduction," and "The pace of balance sheet reduction should be faster than during 2017-2019." This is essentially in line with Brainard’s remarks. Mary Daly, President of the San Francisco Fed, mentioned at another conference that rate hikes are necessary to curb inflation. She noted, "While rate hikes may slow consumption, the economy may slow down but will not enter a recession."

This contrasts with a report released the same day by Deutsche Bank, which predicted that the U.S. would enter a recession in 2023 due to the Fed’s tightening moves. Deutsche Bank is the first major bank to forecast a U.S. recession. It projected, "The Fed will decide on three consecutive 0.5 percentage point hikes at upcoming FOMC meetings," and warned that "the U.S. economy could suffer significant damage."

Meanwhile, immediately after Brainard’s remarks were made public, the 10-year U.S. Treasury yield surged past 2.567% intraday, reaching its highest level since May 2019. The New York stock market plunged across the board. The Nasdaq index, which is sensitive to interest rates and tech stocks, fell more than 2%.