Fed Needs to Do More Than Raise Interest Rates
With so many analysts, not to mention market pricing, having settled on a 50-basis-point interest rate increase by the Federal Reserve this week, it would be understandable to assume that it’s a “done deal” when it comes to what the central bank will announce at the conclusion of its policy meeting on Wednesday. The situation could not be further from the truth.
Several consequential issues remain for the Fed to make progress on if it wants to transition from being part of the problem of economic and financial malaise to being part of the solution. Here are my top four:
Regaining the policy narrative through credible forward policy guidance on rates
Lacking credible policy guidance from the Fed and witnessing inflation numbers that have tended to consistently surprise on the upside, markets have rushed to price in a historically aggressive interest rate path for this year. The more Fed officials have shifted to an increasingly hawkish narrative to catch up with market pricing, the more markets have tilted to pricing in not just more increases put also a bigger front-loading of them. By early this week, market pricing implied three consecutive 50-basis-point increases.
The Fed desperately needs to regain control of the policy narrative if it is to have any chance to land the economy softly. Time and time again, the Fed has failed to influence markets with clear and credible policy guardrails.
The more the Fed continues to chase markets in vain, the higher the probability of another serious policy error as it is forced into one of two corner alternatives: either validate market expectations and risk a costly recession or disappoint them and further deanchor inflationary expectations.