Fed Raises by 75 bps, Esther George Dissents, Markets Sell-Off on Thursday
In one of the more extraordinary Fed days in recent memory, the FOMC came in with the largest interest rate hike since 1994. To give a gut check, this is when Whitney Houston’s “I Will Always Love You” was at the top of the charts. The move was particularly significant given that Powell had recently said that 75 bps was off the table. The Fed funds rate is now a range between 1.5% and 1.75%. The widely watched Summary of Economic Projections (SEP) also indicated that all 18 Fed officials that participate expect the Fed to raise the Fed Funds rate to 3%. At least half of the officials think it may need to go even higher to 3.375%.
It was notable how quickly Fed Funds future expectations moved in the wake of the bad CPI report on Friday. There were also incredibly anomalous moves, in terms of magnitude, in treasury markets. Rates spiked significantly after the disappointing news on inflation but have since made a round trip back to the same levels they were at before the report.
It is unusual in the 2020s for the Fed to depart from their carefully crafted and usually accurate guidance. The thing that might have forced their hands was not the CPI data itself but the University of Michigan survey that showed inflation expectations rising. Consumer expectations have a good historical track record of being predictive of inflation and these expectations influence behavior. Powell also directly mentioned that 75 bps was on the table at the July meeting.
Powell’s comments after were focused on taming inflation and he conceded that a soft-landing was becoming a lower and lower possibility but of course he didn’t fully dismiss such an outcome. Mr. Powell conceded that many of the drivers of inflation depended on factors the FOMC doesn’t control particularly the commodity price spikes associated with the war in Ukraine. Markets initially rose on the comments. Our Head of Research Tom Lee had predicted that the Fed would likely raise 75 bps in the wake of the CPI report last Friday which showed inflation still increasing pretty broadly.
Kansas City Federal Reserve Bank President Esther George dissented in favor of a 50-bps hike. She mentioned that she was firmly dedicated to slowing inflationary pressures but that she thought the pace of rate rises was particularly important. She mentioned rapid movements can have adverse consequences for traditional bank lending done by smaller community banks and for American households. She also stated she saw the move as “adding to policy uncertainty” simultaneously to the start of quantitative tightening. Ms. George has traditionally been hawkish, but she seems to have been concerned with Fed credibility and potential collateral damage from large moves. Her term ends at the beginning of next year.
Neel Kashkari who is regularly considered one of the most dovish members on the FOMC supported the 75 bps move and came out on Friday saying he could be persuaded to repeat a hike of the same level at the next meeting in July. He also urged caution about hiking too much, too fast as George did. He suggested that the Fed could revert to 50 bps in September and keep the hikes going forward at that level until meaningful progress is seen on inflation. He said “Taking a steady approach to driving long real rates higher might help us avoid tightening more than necessary to restore price stability, while ensuring that we do enough.”
Powell made it clear that the Fed is firmly focused on reducing inflation whatever the costs. “The worst mistake we could make would be to fail” to bring down inflation. He added it was not optional to restore price stability. The real economy has been reacting to the Fed policy. The Housing market is cooling, and mortgage rates have gone up quite precipitously. As rates rise, companies are scrambling to lower debts costs. Many companies are buying back debt, pushing out maturities or amending cash-management strategies to mitigate the impact of tightening. Carnival Corp., HP and Motorola all have made such actions. The 10-yr closed at 3.233%.
