June’s 75 bps tightening is the first of what are likely to be aggressive moves so the Fed can catch up when it comes to containing price pressures.
The Fed released its statement following their two-day meeting that concluded on Wednesday, and consistent with a growing chorus of economic consensus as well as a Wall Street Journal “mouthpiece” story on Monday, they raised the Federal Funds rate by 75 bps to 1.5-1.75%. There was one dissenting vote, by Kansas City Fed President Esther George who wanted a 50 bps move: This is a surprise as she has been known to be much more hawkish up to this point.
The statement left no doubt as to the Fed’s focus: Inflation. The FOMC still indicated confidence in the strength of the economy, suggesting that activity picked up after contracting in the first quarter. In prior commentary Fed Chairman Powell removed a 75 bps hike from the table, but also stressed that without price stability full employment is impossible. The May CPI report clearly rattled the central bank, forcing Mr. Powell to revert back to a 75 bps tightening. Though the Fed looks towards the Personal Consumption Expenditure Price Index vs. the CPI as a measure of inflation, Friday’s number was an economic blow as well as a hit to the Fed’s credibility.
During his press conference, Chairman Powell tried to deflect blame for the consequences of the Fed’s past timidity. He alternated between saying the Fed has the tools and the resolve to bring inflation down, while suggesting they have been overwhelmed by events beyond their control, which “raised the degree of difficulty significantly” to achieve their inflation target. In other words, any subsequent recession can’t be blamed on the Fed’s inaction.
Also just before the meeting, on Friday June 10th, the University of Michigan survey data showed inflation expectations becoming unmoored, especially when digging into the report’s details. Below is a chart of inflation expectations 5-10 years ahead, for both the mean as well as the 25th and 75th percentile of respondents. It’s clear in the survey that the Fed is behind the curve on fighting inflation and the Fed’s first job is to regain the credibility that they have lost by acting far too late and far too slowly to address price pressures over the course of the past year.
It’s worth noting that the change in the Fed’s reaction function (from an attempt to forecast future economic conditions to account for the “long and variable lags” for policy moves to an “Average Inflation Targeting” approach) and a focus on “not surprising” markets through the extensive use of forward guidance have both failed. The Fed did not give any further guidance on the process of Quantitative Tightening, which they indicated will less variable than potential decisions on rates.