Gay hiking

War, pandemic and inflation have fueled a complex trio

By Howard Schneider

WASHINGTON (Reuters) – In what now seem like the simplest days of December, when there was only a pandemic to worry about, Federal Reserve officials rallied around the idea that they could keep inflation in check with modest increases in interest rates as the economy and labor market thrive.

A war in Europe has now been superimposed on the health crisis, and when US central bank policymakers meet this week, they will have to decide how badly that optimistic outlook has been damaged and whether their hopes for a “soft” economy landing” have been reduced or eliminated.

The Fed is almost certain to raise its benchmark overnight interest rate by a quarter of a percentage point at the end of its two-day policy meeting on Wednesday. More important will be projections showing how much policymakers think rates will need to rise this year and in 2023 and 2024 to rein in inflation that has exceeded their expectations.

The COVID Inflation Push

If their outlook for the federal funds rate rises above what is considered a neutral level of around 2.50%, it means the mood within the Federal Open Market Committee (FOMC) has changed and its members see a need to eventually dampen the economy – and face an increased risk of recession – to bring the price hike in line. In December, most Fed policymakers predicted that rate would only need to rise to 2.10% by the end of 2024.

“There is no doubt that the FOMC will start raising rates… What everyone wants to know is what will the Fed do next?” Roberto Perli and other Piper Sandler analysts wrote. If new projections show the target federal funds rate rising above 2.50% in the coming years, that “would signal that the majority of the FOMC is so concerned about inflation that they don’t care about risking a recession in order to reduce it quickly. Needless to say, this would be a very hawkish development.

Bumpy landing?


The Fed is expected to release its new policy statement and updated quarterly economic projections at 2:00 p.m. EDT (6:00 p.m. GMT) on Wednesday. Fed Chairman Jerome Powell is due to hold a press conference half an hour later.

On Friday afternoon, investors were expecting Fed rate hikes to cap just below neutral, so an upside move could trigger some kind of shock — maybe even lead to a “reversal” in bond yields with short-term rates rising above longer-term rates. those.

This will arguably be the most important moment for the central bank since the spring of 2020, when officials pledged unlimited support for a pandemic-stricken economy by cutting the federal funds rate to near zero and starting massive bond purchases. Soaring unemployment was the main concern then, and the Fed pledged to do whatever was necessary to maintain the financial stability of households and businesses during the crisis.

Unemployment has now dropped to an all-time low of 3.8%, and households are teeming with cash from pandemic-related government aid programs.

Inflation, three times higher than the Fed’s 2% target and a hot political issue, has become the main threat, not only challenging the Fed’s political prowess but raising the specter of a 1970s-style predicament in which the central bank had to impose a punitive recession to rein in prices.

Fed policy and inflation

This week, the Fed will not only reverse its emergency pandemic measures, it will have to guide the public through the maze of competing economic and geopolitical considerations it juggles, and explain why it can avoid killing the current economic expansion.

Fed rate hike cycles often come with their own particular guidelines, with words like “measured” or “gradual” sprinkled throughout policy statements to indicate the expected pace of rate hikes. Powell recently used less concrete terms like “agile” for a policy that should include regular rate increases this year, but may need to be accelerated or slowed in response to rapidly changing events and conditions.

“Neither data nor fortune favored the Fed” in recent weeks, wrote Tim Duy, chief US economist at SGH Macro Advisors.


The list of issues facing policymakers deliberating this week has indeed grown long.

Since the last policy meeting in late January, inflation has shown no clear signs of slowing, putting the Fed’s current stance even further out of step with a growing economy. Longer-term inflation expectations, a particular concern for the central bank that signals whether it is losing public confidence in its ability to contain prices, have also started to rise.

ICE Inflation Expectations Index

The war in Ukraine has no clear resolution and could fuel inflation even further due to rising energy costs, further disruptions to supply chains or even a reorganization of global trade and of governance which could mean constantly higher prices.

On the other hand, there are signs of the pandemic easing which could provide momentum for a strong recovery. Data released earlier this month showed a sharp increase in job growth in February that beat expectations and upward revisions for January and December. A pause in wage increases last month reduced fears that workers’ wages and prices could begin to rise mutually.

Household savings have remained high through 2021, recent Fed data shows, providing a reserve of savings to help Americans absorb the costs of more expensive gas and food without cutting other spending areas.

Powell, testifying before Congress earlier this month, made it clear that he was focused on inflation and that he was prepared to raise interest rates and in larger increments of half a percentage point if price increases were not slowing down.

But he also acknowledged that the world had become more complicated, in ways that might take time to figure out.

The war in Ukraine “is a game-changer and will be with us for a very long time,” Powell told the House Financial Services Committee on March 2. “There are still events to come…and we don’t know what real effect on the US economy will be. We don’t know if those effects will be long enough or not.

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)