Hopes of a dovish pivot have been crushed, dreams of an imminent pause in rate hikes have been killed and the Federal Reserve appears ready to tighten monetary policy by magnitudes unimaginable just a couple of months ago.
Despite the most aggressive pace of interest rate hike in decades, inflation has remained persistently high. This has forced the central bank into an aggressive policy corner, where it is likely to remain well into 2023, Fed Chairman Jerome Powell said at a Nov. 2 press conference.
"We have a ways to go," Powell said. "There's no sense that inflation is coming down. We're exactly where we were a year ago."
Powell's comments followed the announcement that the rate-setting Federal Open Market Committee, or FOMC, unanimously approved an increase to its benchmark federal funds rate by 75 basis points to a target range of 3.75% to 4%, its highest level since 2008.
If government data does not show that inflation is falling soon, or if it worsens further, Fed officials may be compelled to approve another "mega" hike of 75 basis points or more at their December meeting, said Dec Mullarkey, managing director of investment strategy and asset allocation at SLC Management.
Fed officials "see the risks as asymmetric, meaning: if they do too little, that's a really bad outcome for them, versus doing too much," said Mullarkey. "They've got manic concentration here on getting inflation down and that's what they're going to do."
No end in sight
The Fed's latest rate hike, its fourth 75-bps increase in a row, was widely expected, though some Fed watchers believed this week's decision could mark the beginning of the end of the central bank's hawkish tilt.
Instead, Powell delivered a more somber message on the policy path going forward, with comments that echoed earlier warnings of "pain" for households and businesses as central bankers ratcheted up their efforts to chill the economy.
Even as the Fed has boosted rates by 375 bps since March, Powell said it was "very premature" to even consider a pause in hikes. Powell said the odds of reducing inflation without triggering a recession had diminished, and he cautioned that the Fed's benchmark rate will ultimately be pushed higher than previously expected.
As of Nov. 2, the majority of the futures market was forecasting that the Fed's rate hikes will peak at 5% to 5.25% in March, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market. A week earlier, the majority of the market expected a peak of 4.75% to 5% in March.
Overtightening no mistake
Powell said he would prefer to "overtighten" policy through additional future rate hikes rather than ease off the central bank's aggressive push and risk the highest level of inflation becoming entrenched in the economy.
The October and November reports on the consumer price index, the market's preferred inflation measure, will be released before the Fed's next meeting in December. But even if those reports indicate that inflation has peaked, or even begun a descent, Fed officials are unlikely to slow their policy tightening efforts much, said SLC Management's Mullarkey.
"They do not want to make the mistake that's been made before … where you declare victory prematurely," he said. "You back off and even cut rates and then inflation just absolutely strangles you. Central banks lose their credibility when they get to that point."
Cumulative tightening
Within hours of Powell's comments, about 70% of the futures market expected the Fed to raise rates by 50 bps in December, according to the CME FedWatch Tool.
Rather than being concerned about the pace of the rate hikes this year, Matthew Weller, global head of research at FOREX.com and City Index, said the Fed would instead be focused on how high rates will ultimately be raised and how long they will remain at restrictive levels.
"To use a construction analogy, Powell and company are worried about stripping the screw by having the drill on too fast of a setting, but are willing to risk driving it too deep because they can always loosen it back up as long as it's not stripped," Weller said.
The FOMC wrote in a statement following their meeting that it would account for "cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments" when determining the pace of future increases.
As the Fed's previous policy efforts begin to take root throughout the economy, through higher borrowing costs and reduced spending, central bankers may pump the policy brakes well before inflation is tamed, said Tom Siomades, CIO of AE Wealth Management.
"The Fed will talk about getting us to 2% [year-over-year inflation growth] but the economy will be grinding lower, and spending will lower so they will not need to go much beyond 4.5% [federal funds rate] before the wheels fall off," Siomades said.