Fed resolutely hawkish

Rhetoric around interest rates from the US Federal Reserve remains hawkish, with officials resolute in their commitment to bring down inflation to 2 per cent from current level over 8 per cent.

Ahead of the central bank’s meeting on September 20 and 21, there has been no push-back from any official on the market view around 75 basis point hike – one that is almost fully priced in.

For now, the Fed appears tilted toward to overtightening rather than doing too little, amid concerns the latter may lead to an unmooring of inflation expectations. The economic cost to re-anchor inflation expectations would be substantial, and far greater than tightening too much.

Chair Jerome Powell made this policy bias clear in a recent Q&A session with the Cato Institute, where he spoke of the US experience in the late 1970s, when there were many failed attempts to bring down inflation. Eventually the Fed succeeded, but at significant economic cost.

Powell said rising rates were essential to prevent inflation expectations becoming unmoored, adding that the longer inflation stays elevated, the greater the chance of this happening.

As such Powell said there is urgency to act now, forthrightly, strongly and to keep going until the job is done.

Inflation

Headline US inflation in August is expected to be nearly flat on the back of falling energy prices. However, underlying price inertia remains inconsistent with an overall 2 per cent inflation rate when an extremely tight labour market is underpinning record setting wages growth and thus robust core services inflation.

Financial markets currently put the probability of the Fed hiking by 75 basis points at 90 per cent. This reflects hawkish Fed rhetoric and explicit support for a sizable move from both FOMC Governor Christopher Waller and St Louis Fed President Jim Bullard. These two officials have proved to be reasonable bellwethers in this tightening cycle.

Bullard said the outcome of the August CPI won’t alter his mindset, as he needs more evidence inflation is cooling. Cleveland Fed President Loretta Mester and Chicago Fed President Charles Evans said they were in favour of getting the fed funds rate (FFR) to at least 4 per cent by the end of 2022, which requires at least 175 basis points of tightening in the next three meetings.

A likely profile would be a 75-point hike in September and 50-point increases in November and December.

Ahead

Eventually the pace of tightening will need to slow. Indeed, the minutes of the July Fed meeting showed participants thought it would be appropriate at some point to slow the pace, while assessing the effects of cumulative adjustments on economic activity.

There is broad-based support for taking the policy rate restrictive and to keep it there for some time to ensure inflation is firmly on a path back to 2 per cent.

This could take some time. For example, Mester does not envisage inflation getting back to 2 per cent sustainably until 2024, and a recent paper from the San Francisco Fed has inflation returning to 2 per cent in 2025.

Tom Kenny is a Senior Economist & Arindam Chakraborty is a Junior Economist at ANZ

This story is an edited version of ANZ Research’s US Pulse: Fed will be bold and strong, published September 12, 2022