The Full Story Behind the Fed’s Historic 2022 Change
The year 2022 will be remembered as one of the most important in the history of the Federal Reserve.
the central bank raised interest rates by an accumulated 4.25% this year, the most since 1980.
Between June and November, the central bank raised its benchmark interest rate by 0.75% in four consecutive meetings. Not since 1994 had the Fed raised rates by 0.75% in even a single meeting.
“Over the course of the year, we have taken strong steps to tighten the monetary policy stance,” Federal Reserve Chairman Jerome Powell said at a news conference in December.
“We have covered a lot of ground, and the full effects of our rapid adjustment thus far have yet to be felt,” Powell added. “Still, we have more work to do.”
That job is expected to include more rate increases next year, and the fed funds rate is now forecast to top 5% in 2023. Meanwhile, unemployment will rise and growth will remain sluggish, a Powell scenario. insisted earlier this month it would not constitute a recession.
Wall Street, meanwhile, has penciled in a recession in the US economy by early next year.
As the year began, interest rates were in a 0% to 0.25% range, as the Federal Reserve had not yet begun to withdraw pandemic-era policies intended to help the economy overcome an unprecedented challenge. As the year winds down, the Fed is making its biggest effort in four decades to slow the economy.
How the central bank’s actions, words and forecasts changed is a story investors are unlikely to forget anytime soon.
‘It will soon be appropriate’
Powell began the year by setting the stage for rate hikes, telegraphing that “it would soon be opportune” to increase rates following the first central bank meeting of 2022. At that meeting, the central bank chose to keep interest rates unchanged in a range of 0%-0.25%.
The scale of the changes to come would rock markets throughout the year.
In January, inflation was well above the Fed’s 2% target and price pressures had amplified.
“While the drivers of higher inflation have been predominantly related to dislocations caused by the pandemic, price increases have now spilled over into a broader range of goods and services,” Powell said.
The Fed’s thinking at the time was that it expected inflation to ease over the course of the year, though Powell said that “we will continue to monitor risks, including the risk that high inflation will be more persistent than expected.” This was the era when a debate about whether inflation would be “transitory” still took place.
Inflation had been largely absent since the financial crisis and was thought by the central bank to be transitory when it began to rise after the pandemic in the wake of COVID-locked-backed supply chains. But the transitory soon became persistent.
In March, Russia was waging a war in the Ukraine, sending oil prices soaring and headlines inflation measured by the consumer price index soared to a maximum of 40 years of 8.5%. Excluding food and energy, inflation stood at 6.5%, an unacceptably high level for the Fed’s 2% target.
Acknowledging that inflation was no longer transitory, the Fed moved to raise rates by 0.25% in March after having held the federal funds rate at near-zero since the beginning of the pandemic.
Still, the Fed projected a more modest forecast for inflation than what came to be, forecasting inflation of 4% for 2022 with rates estimated to rise to 1.9% and further to 2.8% in 2023 and hold at that level through 2024. Forecasts that would look dramatically different by year-end.
The start of ‘expeditious’ increases
By May, with a surge in oil prices and other commodities from Russia’s invasion pushing up inflation, the Fed raised rates by 0.50%, noting for the first time it anticipated “ongoing increases” in rates.
“We are on a path to move our policy rate expeditiously to more normal levels,” said Powell. “There is a broad sense on the Committee that additional 50-basis-point increases should be on the table at the next couple of meetings.”
Powell noted inflation had surprised to the upside and that further surprises could be in store.
Consumer prices accelerated by June on a headline basis, prompting the Fed to pull the trigger on what would be the first of four 0.75% rate hikes in a row, an unprecedented action since the Fed started explicitly targeting the fed funds rate in the late 1980s that matched the largest single meeting move since 1994.
With inflation surprising to the upside, the Fed forecasted a steeper path of rate hikes, further raising its estimates for interest rates for the year — up to 3.4% from 1.9% previously. Officials revised higher their expectations for inflation to 5.2% over the course of 2022, up from 4.3% forecast in March.
Powell noted that a 75 basis point rate increase was an “unusually large one,” and that he did not expect moves of that size to be common. “Either a 50 basis point or a 75 basis point increase seems most likely at our next meeting,” said Powell.
Six weeks later in July, the Fed was hiking again by 75 basis points and would do so for two more meetings through November.
‘Pain’ at Jackson Hole
Fed Chair Jerome Powell repeatedly reinforced that the Fed’s resolve to quell inflation wouldn’t be without pain—first in May at a press event, then in August at the Fed’s annual confab in Jackson Hole, Wyoming, and subsequently at post-FOMC press conferences in the fall.
“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” Powell said at Jackson Hole. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
Fed Chair Powell’s commitment to “keep at it until the job is done,” earned him comparisons to former Fed Chair Paul Volcker, acclaimed for taking a relentless stance on fighting inflation pushing interest rates up to double digits.
Powell himself invoked the former Fed Chair, showing the seriousness of his resolve in the fight against inflation at Jackson Hole.
“The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years,” said Powell. “A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”
Inflation proved to be much more of a problem than it has been for the previous four decades, and the Fed is determined to avoid the mistake of the early 1980s, when it cut rates too soon, allowing inflation to come back up fast. That mistake resulted in two recessions close to each other—an outcome the Fed would very much like to avoid this time.
By September, the Fed was upping their estimates for rate hikes yet again, and this time pledging to hold rates at a higher level for longer. Officials saw the fed funds rate rising to 4.4% by the end of the year and 4.6% by the end of 2023 — up from 3.4% and 3.8% respectively.
A time to ‘moderate’
By November, the Fed had again raise interest rates by 75 basis points, while hinting at a potential slower pace in the future.
“In determining the pace of future increases in the target range the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation and economic and financial developments,” the policy statement said.
Powell set the table for a 50-basis point rate hike at the Fed’s December policy meeting, saying in a speech at the Brookings Institution two weeks before the meeting it makes sense to “moderate” rate hikes as the Fed approaches its estimated peak in benchmark interest rates.
“It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down,” Powell said. “The time for moderating the pace of rate increases may come as soon as the December meeting.”
Two weeks later the Fed acted on those comments, pledging to continue raising rates at a slower pace, but yet again raise rates higher than estimated and hold them there longer than previously expected. This as inflation remained high and showed only tentative signs of coming back down.
Powell said inflation data in October and November — pointing to cooling numbers on the consumer price index — are a welcome decline, but will take substantially more evidence to gain confidence inflation is on a sustained downward path.
Fed Chair Powell said that the committee is not at a sufficiently restrictive policy stance yet and that it’s possible officials could raise estimates for rates even higher if inflation continues to be sticky. Powell said he doesn’t see the Fed considering cutting rates unless the central bank is confident inflation is coming down.
While Fed Chair Powell has stopped short of saying a recession is needed to bring down inflation, he noted that reducing inflation will likely require a sustained period of “below trend growth.” The Fed lowered its growth forecast against this month, and now expects just half a percentage of GDP growth next year and 1.6% in 2024.
Officials also now see rates rising to 5.1% next year — with five officials projecting rates could rise as high as 5.25% and two projecting 5.6%. Though the pace of rate hikes is likely to move in 50 or 25 basis point increments, the Fed has repeatedly raised estimates this year for how high rates could go. In September, officials estimated rates would top out at 4.6% before revising these estimates higher.
“[Interest rate projections] show that FOMC participants overwhelmingly believe that inflation risks are on the upside,” Powell said at his December press conference. “So I can’t tell you with confidence that we won’t be raising our top rate estimate again in the next SEP. It will depend on future data.”
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