Last Wednesday, Jerome Powell tried to recreate himself as a ‘hawk’. After much of the year, Powell insisted that inflation was a transient phenomenon, this week the Federal Reserve chairman made it clear he intends to fight it, nor did he rule out the possibility that interest rates would rise faster than expected. “There is quite a lot of room to raise the interest rate without threatening the employment market,” Powell declared, causing markets to lose height on their own.
Meanwhile, the Fed has left interest rates at zero. But Powell left no room for doubt: the face of the Fed for raising interest rates, for the first time since 2018. This move will be felt in the entire global economy.
Powell’s explanation for the planned interest rate hike is simple. The Fed is responsible for maximum employment and price stability. What is the situation on the ground? On the one hand, the U.S. labor market has made an impressive recovery. On the other hand, inflation has soared in the past year to well over 2%, the Fed’s target. The conclusion is obvious: “The economy no longer needs high levels of monetary support,” according to Powell. So the Fed is on track to raise interest rates, probably already in March, and stop its asset purchase program that month.
The situation is different from what it was in 2015
The fact that the Fed intends to raise interest rates was not surprising, it was clear. What was surprising was Powell’s hawkish tone. He stressed how different the situation is from 2015, the previous time the Fed raised interest rates. Unlike since then, today inflation is high, the labor market is showing strength, unemployment has fallen to 3.9%, and the US economy is growing relatively fast (more than its ‘long-term potential’). Therefore, if in 2015 the Fed raised interest rates slowly and carefully, it now appears that Powell is signaling a relatively aggressive move.
Last month it was estimated that the Fed would raise interest rates 3 times this year, and gradually. Now it already seems much less safe. It is clear that the Fed intends to start raising interest rates in March. But will the Fed raise interest rates 4 times this year (or maybe more)? Will interest rates rise soon, instead of gradually over the year? Will he jump the interest rate by half a percent at one time, instead of raising it by a quarter of a percent each time?
At the press conference, Powell was unwilling to rule out any of the options (“We did not start thinking about it”). Instead, he pledged to be flexible and modest, to act on data, and also defined inflation as the major threat to his forecasts.
No more talking about “transient inflation”
When he promises to be flexible, Powell tries to adjust expectations and change his image, after his assessment that inflation will pass has been falsified. Last month, Powell mistakenly admitted, proposing to stop talking about ‘transient’ inflation. Yesterday, he had already explained that the inflation situation had become ‘except worse’ since the meeting of the Open Markets Committee in December, and that no progress had been made on the supply chain front either, including essential components such as semiconductor chips.
The Fed does not have too much to do about traffic jams, the shortage of truck drivers, or the other disruptions that the plague has caused, and that are behind some of the price increases. But according to Powell, price increases have become widespread, affecting a variety of areas in the U.S. economy, and wages have also begun to rise relatively quickly – which could push inflation even higher. Hence the Fed’s intention to act.
The Fed’s decision will be felt far beyond U.S. borders. The Fed dictates what is known as the ‘global financial cycle,’ and its decisions have an impact on conditions in the rest of the world. This is how the International Monetary Fund defined it this week, warning that higher interest rates in the US will increase the cost of credit worldwide. For some countries, especially among developing economies and emerging markets that also borrow in dollars, a particularly challenging period is expected.
The expected rise in interest rates in the US is one of the challenges pointed out by the IMF, which has updated its downward growth forecasts, and talked about a ‘disrupted recovery’. This year, those who pull the forecast down are the two pillars of the world economy: the United States and China.
Among the causes of the slowdown in the US, Gita Gofin, the IMF’s chief economist, explained this week is not only the Fed’s change in plans. And this will be reflected in lower growth.Like Powell, it too marks the ongoing crisis in supply chains as another factor slowing growth in the US. The fear is that the longer the supply difficulties continue, the more inflation will take root.
Goethe Goffin, IMF / Photo: Associated Press, Esteban Felix
Impact of China’s Corona Policy
Whereas the lowering of China’s growth forecast, according to Gopin, reflects the continued contraction of the real estate sector (which, if spread to the entire economy, will have heavy consequences), as well as a weaker-than-expected recovery in private consumption. China’s zero corona, in which severe closures and restrictions are imposed with each outbreak of the virus, could exacerbate global supply disruptions.
Dealing with the corona will continue to play a key role in determining the fate of the economy. Currently, the fund is sending an accusing finger to the West, in rich countries the vaccination rate stands at 70% of the population, while in low-income countries the vaccinated rate stands at only 4%. This is fertile ground for the emergence of new variants of the virus, for the persistence of the plague, and for new limitations.
And if that’s not enough, the fund cites other factors that jeopardize the forecast, including geopolitics – a tangible risk in the days when Russia is concentrating forces on the Ukrainian border. Tensions in Eastern Europe and East Asia jeopardize energy supply, international trade, and cooperation between policymakers, the fund states. And rising food and energy prices have already contributed to social unrest.
A raging virus, winds of war, disrupted supply chains – these are not the materials that usually make up IMF reports, which usually deal with questions of interest rates, deficit levels, and structural reforms. And yet most of the risks to the forecast are downward. However, certainly when it comes to advanced economies, the forecast is still for higher-than-normal growth.
Back to Powell. Could it be that the Fed, like the White House, has also contributed to the jump in inflation? Powell, who was asked about it this week, stated that the question can only be answered in 25 years, when the current crisis can be examined from a historical perspective. Still, he suggested recalling how dramatic the situation was at the beginning of the plague, when the economy closed overnight, and the population was sent to close in on the home: “It was a very strong response in response to a very unique historical event.”
Powell’s rise in interest rates exposes him to another criticism that the war on inflation will come at the expense of workers, who have finally begun to see their wages rise, a goal Powell has set in recent years. And here, once that happens, the Fed starts raising interest rates.
The Fed chairman came up with ready-made answers: he explained that price stability is an essential component needed for the US economy to record a period of prolonged recovery, as in the decade after the financial crisis. Of all the people in the lower strata, who spend almost all of their income on food, fuel, heating and rent. And as mentioned, he thinks the Fed can raise interest rates, without hurting the recovery. .
And what about the stock market? Powell made it clear that this is not his focus: the Fed’s mandate is to provide employment and stable prices. He did not sound concerned about the possibility that raising interest rates would lead to a shake-up that would jeopardize financial stability.
Powell, meanwhile, explained that “property prices in themselves do not pose a risk to financial stability.” And this is because the balance sheets of households, businesses, and banks are in good shape. The message was clear: Powell, the man who has starred in “memes” of social media investors for the past two years, raining dollars in every direction, is not afraid to start turning off the money printer.