Central banks went from the transitory narrative to scrambling to prevent another Great Inflation era, faster than it takes to print $100 billion in Fed Treasuries. In a speech today, US Federal Reserve Chairman Jerome Powell pledged to take extreme measures to curb inflation if needed. The central banker warned this includes the possibility of double-rate hikes, or raising rates to the point of killing growth.
The US Will Aggressively Attempt To Curb Inflation
The Chairman also pledged to raise interest rates at an aggressive pace. “We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” he said.
Just a few weeks ago St Louis Reserve President Bullard said the US Fed should consider “super” rate hikes. A normal interest rate hike is 25 basis points (bps), and a super hike is 50 bps. At the time, Powell said they weren’t off the table. However, it seemed unlikely — now he’s mentioning them. This is a very drastic change from the “transitory” narrative.
He adds, “And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.”
That’s a much bigger deal than most people realize.
To Neutral and Beyond
The Chairman didn’t just glide over going past the neutral policy rate. He suggested it multiple times, including in his speech opening. “There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability,” he said.
The neutral policy rate of interest is the rate where it no longer influences an economy. When interest rates are below the neutral rate, it provides economic stimulus in the form of cheap money. The goal here is to raise the rate of inflation.
Above the neutral rate is when it does the opposite — it slows down the economy. Economies that are running so hot it creates inflation might need a drag, and that’s when they try to slow economic growth. Above the neutral rate is like removing stimulus, which can quickly turn to recession if improperly managed. Neutral makes a lot more sense once you know that. It’s neutral, neither contributing nor slowing down a country’s economic growth.
Powell is pledging to contain inflation even if he needs to push rates to the point it becomes a drag on the economy. This should highlight how dangerous the current elevated rate of inflation is to the economy. The Fed would prefer to risk economic contraction than allow inflation to keep running at this level. Meanwhile in countries like Canada, they’re still under the impression inflation will go away on its own…
Recency bias (“people keep saying rate hikes are coming and yet they never do”) combined with a lot of magical thinking (“real estate is such a large part of Canada’s GDP that the BoC would never risk hiking rates”) is blown out of the water by the cold reality that we are at the mercy of the US Fed. The Fed doesn’t care at all the state of Canadian real estate and will hike rates to suit the US economy. Canada can follow with its own hikes, or not and watch the dollar plummet. A conundrum of our own making.