Fed in the dark

Therefore, the name of Jerome Powell in economic history will remain associated with the first increase in the key rate of the US Federal Reserve by 75 bp. for almost 30 years. He thus replaced Alan Greenspan, the last head of the Federal Reserve to lead the movement, in 1994.

Author: Engerran Artaz, Foundation Manager and Olivier de Berrange, CIO

Enguerrand Artaz - LFDE
Engerran Artaz, fund manager

However, such a significant increase in rates was hardly a surprise. The sudden acceleration of inflation in May 2022, with a sharp rise in US household inflation expectations for 5-10 years, has led investors to largely anticipate this scenario. That could be repeated in July. Thus, from this point of view, the Fed lived up to expectations. The same with the revision towards raising its forecast for inflation and the level of key rates at the end of the year – raising to 3.4%, ie at least another 175 bp. 2022 against 2.8% expected at the meeting in March and 4.0% at the meeting in December 2021! Apart from the new acceleration of monetary policy, which may seem alarming, these elements can be viewed quite positively: the Fed is ready to actively fight inflation, and if it is aware of the risk to economic growth, it will not make it shudder. . Some changes to the initial statement of the Monetary Policy Committee (FOMC) conveyed the same message.

Olivier de Berrange
Olivier de Berrange, CIO

However, Jerome Powell’s words during his speech were much less legible. He reaffirmed that there is a way to a soft landing, reducing inflation without compromising growth, and ruled out any risk or desire for a recession. It is true that it was difficult for the head of the Fed to give another speech, but this is somewhat contrary to the sharp revision of the FOMC in the direction of reducing growth prospects. Moreover, Jerome Powell later clarified his remarks, explaining several times that the trajectory of the American economy is increasingly dictated by exogenous elements: the conflict in Ukraine, Covid in China, oil prices, bottlenecks and more. He also acknowledged that while the central bank was “very attentive” to the danger of going too far, it could not risk lowering inflation. We can say that the dynamics of inflation is more important than the dynamics of growth. It is difficult for investors to navigate this game of shadows, in which everyone, optimistic or pessimistic, can find something to feed their thoughts. Maybe that’s basically what the Federal Reserve is looking for, waiting to see things more clearly.

This is another lesson that can be learned from this Fed meeting. We knew that the Federal Reserve would be flexible, that it was “data-dependent,” in other words, that it was adapting to the latest economic data, but it seldom seemed to float so strongly. The first example is the increase in the rate by 75 basis points – in response to data published a few days earlier – when he had largely announced an increase of 50 bp. for several weeks.

But the words of Jerome Powell are instructive in this regard. The head of the Fed repeated a lot about both growth and inflation in the last part of his press conference “we just don’t know.” An exercise in honesty that may be interesting, or acknowledging helplessness in a situation where the central bank can only control certain aspects? Probably, both, in the end, are quite noticeable decline in visibility on the trajectory of strengthening US monetary policy, as well as the Fed’s ability to solve the inflation / growth equation. If a few weeks ago it seemed that the Fed was in complete control of the situation, today there is nothing to calm down the already very nervous markets.

The information provided is the result of an internal study conducted by the management team as part of its UCI management activities, and not a financial analysis in the sense of the situation.

This analysis is based on the best sources we have and publicly available information. They are in no way mandatory for La Financière de l’Echiquier and are not investment advice.