For a few weeks, markets have enjoyed an unexpected period of recovery despite the war in Ukraine. Few expected it. That appearance of stability has been shattered this Tuesday after the Federal Reserve (Fed) has turned off the music on Wall Street again to remember that it is going to accelerate the monetary adjustment in the US from May 3 and 4dates of your next meeting. Lael Brainarddeputy governor of the central bank and second in command after Jerome Powell, has been in charge of sending an aggressive message to investors and economic agents.
“It is very important to reduce inflation. Accordingly, the Committee will continue to tighten monetary policy methodically through a series of interest rate increases and will begin reduce the balance at an accelerated pace as early as our May meeting”assured the woman who escorts Powell to meetings. Brainard hinted that the rate moves could be larger than those made at the last meeting in March, when the central bank raised the price of money by 25 basis points in its first move higher since December 2018.
The scenario now is radically different and much more dangerous. On April 10, the US will know the historical inflation data for March, after the rate jumped to 7.9% year-on-year in February, the highest reading since 1982. If so, the Fed will not take long to act forcefully because the economy continues to grow, the labor market is strong and price destabilization justifies it.
“Inflation is too high and subject to upside risks. The committee is prepared to take stronger action if inflation and expectations indicators indicate such action is warranted,” he summarized. The Mainard’s aggressive rhetoric It has a lot to do with the fact that the Fed does not meet in April and does so in May. In fact, investor sentiment has been positive on the stock market despite the selloff in bonds. Debt yields have climbed to four-year highs and do not justify continuing to quote an expansionary policy for stocks.
Brainard has wanted to leave clear the Fed’s position to avoid misunderstandings and Wall Street seems to have taken notice with the biggest drop in the last month, especially in the technology sector. The banker has cited the great inflation tamer of the early 1980s, a period known for drastic rate hikes and the entry into recession that managed to cool down an overheated economy. “Forty years ago, P.Paul Volcker pointed out that the dual mandate [estabilidad de precios y empleo] it’s not an either/or proposition, but runaway inflation “would be the greatest threat to continued growth of the economy…and ultimately to jobs,” Brainard read during a conference in Minneapolis.
The forex market reaction led to a further strengthening of the dollar against the euro, to the level of 1.08, while bonds once again registered falls in prices due to sales and increases in profitability: 1.74% at 1 year, 2.52% at 2 years, 2.7% at 3 years and 2.55% at ten years. Once again, the reconstruction of the inverted curve -greater interest in short terms than in long terms- once again generated concern among investors. The dow jones closed the day with a fall of 0.8%, from 1.26% for the S&P 500 and the nasdaq completed one of its worst sessions with a decline of 2.2%.
For Brainard, the Fed must start reducing its balance sheet immediatelythat is, to sell part of its bond portfolio starting in May. That the biggest buyer of debt in the last two years goes to the selling side worries, at least, anyone who looks at the market. Experts have doubts about the capacity to absorb this output of paper if it is not done in a controlled manner. The central bank has increased its balance sheet by 140% since the end of 2019until the 9 billion dollars. The most conservative calculations indicate that it could shrink by 500,000 million in 2022 alone, and around 1.2 trillion from 2023 if nothing goes wrong.
“Today inflation is very high, especially in food and gasoline. All Americans face higher prices, but the burden is particularly great for households with the most limited resources. Therefore, lowering inflation is our most important task, maintaining a recovery that includes everyone. This is vital to maintaining the purchasing power of American families,” she noted. The fight against inflation hides a secondary effect that will also damage the purchasing power of millions of Americans: the increase in financial costs. Benchmark 30-year US mortgage rates have soared by more than 100 basis points in a short time, crossing the 5% level for the first time since late 2018 on Tuesday.