US Federal Reserve likely to raise interest rates by half a point in May as Hawkish Pivot deepens

“I think that’s a reasonable option for us because the federal funds rate is very low,” Federal Reserve Bank of New York President John Williams said in an interview with Bloomberg Television on Thursday. “We need to bring monetary policy back to a more neutral level.”

His comments helped push 10-year government bond yields up to 2.80% from around 2.70% earlier after the interview.

The comments from the New York Fed governor are the latest to underscore the US Federal Reserve’s plans to hike interest rates back to pre-pandemic levels or even higher. In addition to the quarter-point move they made last month, that means about 200 basis points of tightening over the remaining six Fed meetings this year to bring rates to about 2.5%.

That message was clearly heard by investors. Interest rate futures are almost fully priced in for a half-point hike at the Fed’s May 3-4 meeting, though officials may also announce a start date for beginning the downsizing of its nearly $9 trillion balance sheet.

Williams expressed confidence in the Fed’s ability to soft-land the economy — easing inflationary pressures without forcing a sharp rise in unemployment — and said the Fed’s forward-looking statements on its policy plans had already got the ball rolling.

“We’ve seen dramatic, significant movement in yields and financial conditions in recent months and that already positions policy well to rebalance supply and demand,” he said.

US consumer prices rose 8.5% year-on-year in March, the sharpest rise since 1981. The war in Ukraine has pushed up food and energy costs and pushed headline inflation further from the Fed’s 2% target.

According to the US central bankers, they were slow to react and are now seen as determined to catch up.

“Lose fiscal policies, supply chain disruptions and accommodative monetary policy have pushed inflation far higher than I — and my FOMC colleagues — are comfortable with,” said Patrick Harker, president of the Philadelphia Fed Bank, in a speech at Rider University in Lawrence Township, NJ, adding that he is concerned that inflation expectations are “getting out of hand.”

But consensus among policymakers is beginning to crumble about how far, if at all, they need to go beyond what they see as “neutral” interest rate levels.

Fed doves argue that until they see how the economy reacts to the already expected tightening in financial markets, they need not commit to doing more than bringing rates to neutral.

They also point to the balance sheet loss as another factor cooling the economy. Minutes of their March meeting showed officials supporting a plan to shrink it by $95 billion a month. In a question-and-answer session following his speech, Harker said the balance sheet will be “on schedule” and the process will begin “soon”.

Fed Governor Lael Brainard, who is awaiting Senate confirmation to become vice chairman, said the combination of higher interest rates and a smaller balance sheet will bring inflation down to 2% over time. She also cited shifts in market expectations as evidence that the Fed’s forward guidance has already tightened financial conditions.

“In terms of the exact pace of this series of session-to-session hikes in interest rates, I don’t really want to focus on that,” she said on Tuesday.

“By rapidly moving to a more neutral stance, it gives the committee two-way choices,” Brainard added, introducing an element of cross-risk for rates if the economy starts to sputter.

Some economists have expressed concern that the Fed could push the economy into recession by raising interest rates too much.

“Now it is clear that they will rise by 50 basis points in May,” said Thomas Costerg, senior US economist at Pictet Wealth Management basis points.

But hawks like James Bullard of St. Louis want rates above 3% this year and call it wishful thinking to propose inflation without slamming on the political brakes.

Treat the half point

Fed Governor Christopher Waller, who was Bullard’s research director in St. Louis before moving to the Fed board in Washington in 2020, said the economy could handle a half-point hike in May and possibly June and July as well.

“I see no value in shocking the markets; We’re not in a Volcker moment,” he said in an interview with CNBC on Wednesday. “We will do everything we can to bring inflation back down, but we can do it in an orderly manner without causing much stress in financial markets.”

Cleveland Fed President Loretta Mester also expressed confidence in the central bank’s ability to tame inflation without derailing the economy during an event organized by the University of Akron on Thursday.

“Our intention is to reduce housing at the pace needed to better match demand with constrained supply to bring inflation under control while maintaining expansion in economic activity and healthy labor markets,” Mester said.

This story was published from a wire agency feed with no changes to the text. Only the headline has been changed.

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