We Have Lift Off

Jacob Hess

March 16, 2022

• FOMC
• Inflation

Today, we have lift off. The long awaited day where the Fed takes a more hawkish stance against inflation finally came. The FOMC elected today to raise the Federal funds rate target range by 0.25% to 0.25-0.50%, the first time the lower bound has been above 0% since the onset of the pandemic. While the move was expected, it also seemed significant in that the slight tightening is the beginning of a larger move to gradually lift easy financial conditions from the US economy.

Press Release

The FOMC was quick to point to "strong" job gains and "elevated" inflation, references to the committee's dual mandate, as the main drivers behind their decision to raise the Fed funds rate. And while the "highly uncertain" implications of the Russia-Ukraine war exist, they came second to the strength that the economy has shown in the past year. Whether that uncertainty plays a part in the Fed's monetary path remains to be seen, but two things suggest that current conditions in Europe aren't severe enough to rock the boat.

The first is the FOMC's willingness to admit that "ongoing increases in the target range will be appropriate." It might seem like a flexible statement to some, but when the Fed speaks like this, it is essentially issuing a forward guidance on policy. Barring a severe escalation in the war in Eastern Europe, we can expect several more rate hikes in 2022. The second is the near consensus vote on the 0.25% rate hike that only saw one dissenter in Bullard. If the new Ukrainian conflict had altered the intention to hike 0.5% into a 0.25% move, there may have been more push back.

Economic Projections

In addition to the announcement of a vital 0.25% rate hike, the Committee released March projections after three months of mulling over the December projections. And there was clearly a lot of mulling.

• 2022 GDP Growth: 4.0% -> 2.8%
• 2022 PCE Inflation: 2.6% -> 4.3%
• 2022 Core PCE Inflation: 2.7% -> 4.1%
• 2022 Fed funds rate: 0.9% -> 1.9%

The sharp rise in FOMC members' inflation expectations has had a clear impact on the expected path of monetary policy in the US. As of March, no FOMC member sees inflation easing below 4.0% this year. Last December, no FOMC member saw inflation over 3.0% this year. In the estimates of core inflation, there is a similar trend which turns out to be a subtle admission that inflation is almost certainly broad based and can no longer be blamed entirely on rising energy prices and COVID categories of CPI. As a result of these things, we get an aggressive dot plot projecting at least another 1.0% of rate hikes in the most dovish scenario and as much as 2.75% in the most hawkish.

Perhaps the most concerning development is the downtick in the median expected US GDP growth of about 1.2 ppts in 2022 with virtually no increase in the expected growth in 2023 and 2024 suggesting that the downward revision is a result of lost growth, not delayed growth. The whispers of "stagflation" should get stronger. However, it should be no surprise that a steep forward rate hike path will come with growing pains in the economy. The real question is: how much has the Fed factored potential effects of the Russia-Ukraine war in this estimate? The answer is likely not at all. Regardless, supply disruptions are occurring already and are weighing on economic indicators that help forecast economic output. The Atlanta Fed's GDPNow model has projected Q1 2022 SAAR QoQ growth at around 1.2% (as of March 17), a fairly anemic rate compared to the "Blue Chip" consensus that started around 3.7% SAAR QoQ at the beginning of the year.

The main message to glean from the FOMC March meeting is that the Committee is in base case mode. A steady, gradual hiking cycle with steps of 0.25% has always been due in order to fight inflation, but that base case could face realignment as uncertain economic environments develop. The first impression is that the status quo (for the US) is likely to persist, and that realignment is unlikely. Per the base case, another 0.25% in May is on the cards.