Federal Reserve Chairman Jerome Powell testifies at a House Financial Services Committee hearing titled “Overview of Treasury and Federal Reserve Pandemic Response” at the Rayburn Building on Wednesday, December 1, 2021.
Tom Williams | CQ-Roll Call, Inc. | Getty Images
The Federal Reserve is likely to be “increasingly hawkish” in its approach until the end of 2022, says Mark Zandi, chief economist at Moody’s Analytics.
The Fed is expected to raise interest rates by a quarter point on Wednesday, marking the first rate hike since December 2018. It also reflects a significant departure from easing introduced to help the economy amid the pandemic.
The expected rate hike reflects “where inflation is, where inflation expectations are, and just given the strength of the economy and the booming labor market,” Zandi said. The Fed’s decision is further exacerbated by uncertainty about the consequences of a Russian invasion of Ukraine and further disruptions to the supply chain.
“If you add to all this, it says that the Fed should normalize interest rates quickly, and I think at the moment faster than they think, at least in terms of their latest forecast, and perhaps even faster than they think. markets at this point,” Zandi said.
Nearly half of the respondents in the latest CNBC Fed poll said the central bank had raised rates five to seven times this year. While the poll shows the rate hike cycle ending at peak fund rates of 2.4%, half of all respondents said they think the central bank may need to raise rates above neutral to bring inflation under control.
Zandi said there may be worries about stagflation, but he believes the Fed will “lock it in before we actually get stagflation. I don’t think they will tolerate stagflation because they know, based on historical experience, that if we fall into this scenario, we will end up in a recession.”
Respondents to a CNBC Fed poll see a 33% chance of a recession in the US over the next 12 months, up 10 percentage points from the Feb. 1 poll.
Recent action in the bond market, indicating a narrowing spread between 2-year and 10-year Treasury bonds, has heightened fears of a yield inversion that has signaled a recession in the past.
For now, Zandi said fixed income markets are saying “the number one issue here that they need to address is high inflation, inflationary expectations. But to do this without destroying the economy, without pushing it into recession, is very difficult. … right now the bond market is signaling a high probability that the Fed will make a mistake and fail.”
“I don’t think the market is signaling a recession, but they are thinking in the same vein as me that it will be very difficult for the Federal Reserve to land the plane on the runway with everything that’s going on. happens and whatever they need to do.”
This uncertainty was certainly noted by Federal Reserve Chairman Jerome Powell in his speech to Congress on March 2.
“Designing an appropriate monetary policy in these circumstances requires recognizing that the economy is developing in unexpected ways,” Powell said. “We will need to respond quickly to incoming data and changing perspectives.”