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The Fed’s restrictive communications flash targets the skeptical market: McGeever

ORLANDO, Fla. (Reuters) – The Federal Reserve has stepped up its anti-inflation rhetoric for the new year to keep up with scorching labor markets and rising consumer prices – but the speed and breadth of its change of tone could just as much be forcefully Money markets have to do to take it more seriously.

FILE PHOTO: The Federal Reserve Board building on Constitution Avenue is pictured in Washington, United States on March 19, 2019. REUTERS / Leah Millis / file photo

With pandemic-induced biases still plaguing monthly economic figures and COVID-19 still raging, the shift from a more relaxed “wait and see” attitude, where incentives are gradually removed, to an urgent Hawkish attitude has been staggering.

Despite some criticism that Fed Chairman Jerome Powell was only backing up his anti-inflation references to secure his renomination, the Fed move came from across the spectrum of the Federal Open Market Committee.

Take San Francisco Fed President Mary Daly, a labor economist and inequality expert who is considered one of the most reluctant members of the FOMC.

In mid-November, Daly insisted in two speeches that inflation would ease. A rate hike would not fix supply chain bottlenecks and other temporary price-driving problems, but damage jobs and the economy.

“Uncertainty requires that we wait and watch,” she said on November 11, adding on November 16, “Running upside down in the fog can be expensive. Patience is the boldest action we can take. “

Last week she said policies “definitely” need to be adjusted, albeit cautiously, to fight inflation.

A brief timeline of the Fed’s latest guidance is helpful.

At the end of September, half of the 18-strong FOMC saw no rate hikes until at least 2023. The US futures markets and Wall Street heavyweights like Goldman Sachs did not factor in a rate change for this year.

When the FOMC began November 2-3, markets were only anticipating a full quarter-point rise that year, and that was only around September.

The FOMC turned the screw at its meeting in mid-December. It announced three rate hikes this year, one more than the market was pricing in at the time, and said it would accelerate the reduction in bond purchases in March.

As a final twist, the minutes of that meeting, released Jan. 5, also revealed that the FOMC has begun talks on reducing its total assets.

The markets finally got the hint. The futures markets are now pricing in four rate hikes of 25 basis points in 2022 almost entirely from March onwards. The economists at Deutsche Bank, JP Morgan and Goldman Sachs have turned their old forecasts on their head and are also aiming for a tightening of 100 basis points this year.

PLAYING UP

This dramatic price adjustment in the short-term interest rate markets for 2022 seems to be exactly what the Fed wanted. Several regional Fed presidents have given markets that control since the New Year, and Powell himself offered no resistance at his Senate confirmation hearing on Tuesday.

“You know what you are doing. I think that was on purpose, ”said Joseph Wang, a former senior trader on the Fed’s Open Markets Desk.

Wang believes that the strength of wage growth and inflation has recently become concentrated in the minds of FOMC members, that the Bank’s dual mandate of price stability and maximum employment is about to be fulfilled.

Whatever the reasons for their restrictive turn, he believes Fed officials will have been concerned they didn’t take the market, hence the aggressive communications frenzy to bring the market into line.

The first warning shots were fired in November. The Fed announced that it would soon begin scaling back its $ 120 billion monthly bond purchases, and Powell said it was no longer right to call inflation “temporary”. Then in December the FOMC signaled that three rate hikes were due in 2022 and the market finally caught up.

But despite the expected turnaround in 2022, the market still doesn’t believe the Fed will be willing or able to hit its own so-called neutral or “final” rate of 2.5% – with futures until 2025 with key rates below 2%.

This is important for investors trying to figure out the longer term horizon for official interest rates. If the tightening cycle ends earlier than the Fed expects, long-term bond yields and the dollar could also be curbed, while maintaining high-octane technology stock valuations.

But that assumes that there is a clear picture at all in political or market circles.

David Blanchflower, Dartmouth College economics professor and former Bank of England politician, says it looks like a three-line whip has been placed on FOMC members for talking harshly about interest rates. But it cannot have anything to do with economics.

“You have no idea what’s coming in 2022. They have no data and no forecasting model so it is right to wait. You are lost, ”he said.

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever; Editing by Andrea Ricci

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