When will FED hike rates?

Fed Chairman Powell said that central bank will not raise interest rates until there are signs of a "broad and inclusive" recovery in the job market and economy.

The conduct of monetary policy has changed out of all recognition since the last time major nations, like the US had a real inflation problem. Some might argue that this was as far back as the 1970s with the oil price shocks, or perhaps the early/mid 1990s when the Fed had to slam on the monetary brakes. But whatever the reference point it is still clear that the conduct of policy has changed and in the Standard Bank’s view that might have lulled the market into a false sense of security about how far rates might have to rise to keep inflation under wraps.

For a start, monetary policy since the financial crisis – and even before for some like the BoJ – has been about vying with, and even passing through, the zero lower bound for policy rates. New monetary measures have been used, like quantitative easing to extend the monetary largesse a bit further. In addition, central banks have introduced countless tools to explain policy such as forecasts, statements, forward guidance and more. In the last big global inflation shock of the 1970s, some countries did not even have central banks making monetary policy; it was down to governments (the UK). So policy has come on leaps and bounds and some would say that’s a good thing because it has helped to keep inflation down and rates low; something that is crucially important when the world has been racking up higher and higher levels of debt that make it even more exposed to any sudden increases in rates.

But this brings potential costs. For if the markets have been so pandered too by central banks that are eager to lay out the future for monetary policy in excruciating detail, there is a risk that any deviation towards a more hawkish policy could crush sentiment – and crush economies.

“That’s probably why we hardly ever see major central banks surprise the markets when they unveil hawkish moves, like rate hikes. In other words, central banks are rather hamstrung pushing out fast, unanticipated hiking moves, which is not the same as the situation they faced 20 or 30 years ago. That’s fine as long as the central bank does not face a big inflation risk. But what happens when it does face such a threat, as might be the case now, for instance? We don’t think central banks can go back to the policies of yesteryear and just throw out quick-fire rate hikes with abandon. That might be part of the reason why market expectations concerning future rate hikes are quite becalmed”, MR. Steve Barrow, Head of G10 Strategy at Standard Bank said, adding, for instance, even though the market perceives that the Fed faces a potentially tricky inflation problem, EUR/USD futures strip only sees implied rates get up towards the 2.5% region over the next decade. That’s lower than the 2.7% peak we saw in the last cycle, the 5.5% before that and the near 7% high in the cycle before that. In other words, a consistent feature of rate cycles is that the peaks fall. That’s due to many factors, probably some of which are related to the way in which the Fed and other central bank conduct policy now, as we have discussed.

However, will it always be like this? Probably not if the Fed faces a more serious inflation problem now, and perhaps especially not if its new policy of allowing an inflation overshoot means that rates will have to rise more in the future than they would have done under the old policy to get inflation back to target.

In short term, FED might have to start off very slowly, as usual, with talk about tapering, then actual tapering… but, once it gets on to rate hikes, which we think will be in the second half of 2023 it can probably move up through the gears and take policy rates up far more quickly than currently anticipated in the futures market. Fed may start off slow but the result (or cost) of this will be a speeding up once rate hikes begin, said Mr. Steve Barrow.

In a previous testify before a U.S. House of Representatives panel, FED Chairman Jerome Powell reiterated to Congress that the central bank will not raise interest rates until there are signs of a "broad and inclusive" recovery in the job market and economy. "We will not raise interest rates preemptively because we fear the possible onset of inflation. We will wait for evidence of actual inflation or other imbalances," Powell said.

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