The Federal Reserve is on an inflation-busting campaign. During the September meeting of the central bank’s policy-making arm, the Federal Open Market Committee’s (FOMC) members raised the benchmark federal funds rate by 75 basis points to a target range of 3 percent to 3.25 percent, the highest level since 2008.
According to the dot-plot—a survey of rate-setting committee members and their economic projections—interest rates are projected to climb to 4.4 percent by the year’s end and to 4.6 percent in 2023.
Fed officials believe the rate increases will curb demand, which would be the panacea to rampant price inflation. Amid concerns that would potentially trigger a sharp economic downturn, Fed Chair Jerome Powell and his colleagues believe the “pain” is necessary to reintroduce price stability into the U.S. economy.
But how did conditions in the United States get to this point anyway? It all started when market turbulence formed during the first wave of the coronavirus pandemic.
Early Days of the Pandemic
In 2019, the Federal Reserve cut interest rates three times, for a total of 75 basis points, even as the economy chugged along. The country added 2.1 million new jobs, the unemployment rate finished the year at a 50-year low of 3.5 percent, and the economy expanded at a robust annual pace of 2.3 percent. But the Fed still intervened by cutting rates, lowering the benchmark to a range of 1.5–1.75 percent.Raphael Bostic, president of the Federal Reserve Bank of Atlanta, was unconcerned about the effects COVID-19 would have on the U.S. economy in early February 2020. While speaking on the sidelines of a Global Interdependence Center conference in San Diego, he rejected the idea that the coronavirus would ripple through the world economy; as such, he said, this “hasn’t changed my outlook or my expectation about our rates path.”
A trader works on the floor of the New York Stock Exchange shortly before the closing bell in New York, on Feb. 25, 2020. Reuters/Lucas Jackson
During an interview with CNBC on Feb. 21, 2020, James Bullard, president of the Federal Reserve Bank of St. Louis, dismissed the idea of cutting interest rates, explaining that expectations for easing would dissipate once concern about coronavirus subsided.
“There’s a high probability that the coronavirus will blow over as other viruses have, be a temporary shock, and everything will come back,” Bullard told CNBC at the time. ”But there’s a low probability that this could get much worse.”
Then-Fed Vice Chair Richard Clarida told the National Association for Business Economics (NABE), on Feb. 26, 2020, that it would be “too soon to even speculate about either the size or the persistence” of the coronavirus. He suggested the United States could handle some volatility because the economy was in a “good place.”
“U.S. inflation remains muted,” he said. “And inflation expectations—those measured by surveys, market prices, and econometric models—reside at the low end of a range I consider consistent with our price-stability mandate.”
After reaching an all-time high of 29,398, the Dow Jones Industrial Average shed more than 10,000 points in about a one-month span. During this intense selloff, the S&P 500 Index tumbled to just above 2,300 from 3,380. The tech-heavy Nasdaq Composite Index also plunged nearly 3,000 points after enjoying a record-high close at 9,600.
Everything changed on March 15, 2020.
In an emergency move announced on a Sunday, the Fed confirmed it would slash interest rates to zero and begin a fresh round of quantitative easing. This program consisted of $700 billion worth of asset purchases, including U.S. Treasurys and mortgage-backed securities (MBS).
“We will maintain the rate at this level until we’re confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals,” Powell said during a press conference call.
One week later, the central bank surprised financial markets by unveiling the mother of all monetary-easing plans. The first was an initiative to acquire an unlimited amount of Treasurys and MBSs to support the financial market. The second was a $300 billion lending program to help companies that were forced to shut because of the public health crisis. The final proposal was to purchase corporate bonds and exchange-traded funds (ETFs) that hold these investments, effectively emulating the Bank of Japan.
The Fed’s extraordinary measures, as well as the massive fiscal stimulus and relief efforts from Presidents Donald Trump and Joe Biden, led to one of the greatest bull markets in U.S. history, as the leading benchmark indexes, commodities, cryptocurrencies, and many other asset classes soared to record levels or tested multiyear highs.
Inflation Is ‘Transitory’
The U.S. annual inflation rate remained under the central bank’s 2 percent target rate throughout all of 2020. It wasn’t until early 2021 that the Consumer Price Index (CPI) started to accelerate.Despite warnings from top economists and market analysts, leadership at the Federal Reserve rejected inflation concerns.
During a press conference call on Jan. 27, 2021, for example, Powell was ostensibly not too concerned about rampant inflation, noting that “we have tools” to fight “uncomfortable” and “sustained” inflation rates.
“It’s far harder to deal with too low inflation,” he said.
Two months later, Powell warned that there might be a bump in inflation, but assured the House Financial Services Committee that it “will be neither particularly large nor persistent.”
For several more months, he insisted that inflation was “transitory” and that it would eventually wane.
“The incoming data are very much consistent with the view that these are factors that will wane over time, and then inflation will then move down toward our goals,” Powell told the House Select Subcommittee on the Coronavirus Crisis.
It wasn’t only Powell who shared that sentiment. John Williams, president of the Federal Reserve Bank of New York, forecasted that inflation would slide to 2 percent in 2022. Bullard also noted that some of the inflation was transitory. Clarida stated that price growth in 2021 would have “only transitory effects on underlying inflation.”
When inflation was clearly spiraling out of control, hovering around 8 percent at the time, Powell officially retired the word in front of Congress on Nov. 30, 2021.
“We tend to use [the word transitory] to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean,” he told the Senate Banking, Housing, and Urban Affairs Committee. “You’ve seen our policy adapt, and you’ll see it continue to adapt. We’ll use our tools to make sure that higher inflation does not become entrenched.”
Let the Tightening Begin
For the first time since 2018, the Fed pulled the trigger on a quarter-point rate increase, raising the fed funds rate to a range of 0.25–0.5 percent. In May, the FOMC lifted rates by 50 basis points and announced a plan to unwind its $8.9 trillion balance sheet beginning June 1.At the FOMC meeting in June, Powell and his colleagues raised rates by 75 basis points, the biggest boost since 1994.
“Clearly, today’s 75 basis-point increase is an unusually large one, and I do not expect moves of this size to be common,” Powell said, although the Fed increased rates by 75 basis points at each of the next two meetings.
When the August Consumer Price Index (CPI) came in at a hotter-than-expected 8.3 percent, there had been some expectation that the Fed would choose to move ahead with a 100 basis-point boost. However, the Fed kept in line with market estimates, and is now projected to approve a 75 basis-point hike in November and a 50 basis-point jump in December.
In recent weeks, the message across the Federal Reserve system has been uniform and simple: Interest rates are going up, and they will stay higher for longer.
The Federal Reserve Board building on Constitution Avenue is pictured in Washington, D.C., on Mar. 27, 2019. Reuters/Brendan McDermid/File Photo
According to a CNBC Fed Survey of economists, fund managers, and strategists, the fed funds rate is expected to reach 3.9 percent by December and climb to 4.3 percent in March 2023. They then anticipate the fed funds rate to ease to 3.8 percent in December 2023 and fall to 3.2 percent a year later.
The key objective for the central bank is price stability, even if it means “pain” for businesses and households, the Fed chair said.
“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 stated during his address at the Jackson Hole Economic Symposium in August. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
The expectation on Wall Street is that the Fed will trigger a sharp economic downturn, while others fear that the institution could be overtightening monetary policy. And this comes as more chief financial officers (CFO) believe inflation has yet to peak.
A recent CNBC CFO Council Survey found that 57 percent of executives think “inflation is here to stay.” Close to half (48 percent) of respondents are penciling in a recession sometime next year.
The final gross domestic product (GDP) reading from the Bureau of Economic Analysis (BEA) found that the U.S. economy slipped into a technical recession amid back-to-back negative growth rates.
Throughout this month’s post-FOMC meeting press conference, Powell abandoned the idea of a soft landing and hinted at a growth recession.
“The chances of a soft landing are likely to diminish,” he said. “No one knows whether this process will lead to a recession or, if so, how significant that recession would be.”
