Fed walks the walk

Given the steady stream of hawkish rhetoric from the Federal Reserve over the past several weeks, it can have surprised no-one that today's FOMC meeting ended with a double-barrelled shot of tightening. The Fed raised the funds target range by 50 basis points, bringing it to 0.75-1.0 percent, and also detailed its plans to shrink its balance sheet by reducing its holdings of Treasuries and other securities. 

Even before today's announcement, the sharp selloff in both equity and fixed income markets had led to warnings that the Fed would not be able to bring inflation back to its 2 percent target without tipping the US economy into recession. The recent report that US GDP slipped in Q1 seemed to give extra urgency to such warnings, but the press release correctly notes that "household spending and business fixed investment remained strong. Job gains have been robust in recent months, and the unemployment rate has declined substantially". 

Some of these warnings of recession almost seemed to imply that the FOMC was flying blind, unaware that its tightening was all but certain to lead to selloff in major markets. This is, of course, ridiculous, and today's press release seems carefully designed to reassure markets that the Fed knows what it is doing.  As a result, the tone is perhaps a little more dovish than some market participants had feared.  The release makes it clear that the Fed expects to continue tightening in the months ahead, but also stresses that it will be ready to change course if circumstances require it to do so. 

The key word in the release is "appropriate", and the FOMC uses it twice:

"With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong".

and

"In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook". 

It can reasonably be assumed that the FOMC's view of an appropriate stance for monetary policy is one in which interest rates are neutral, that is, neither directly expansionary nor contractionary for the economy. That rate is still probably 150-200 basis points higher than the newly-set  funds target, and it is of course possible that the Fed would have to move rates above neutral for a time if inflation proved particularly sticky. As things stand, therefore, there are several more rate hikes to come, but markets can be reassured that the Fed is not on auto-pilot, and can change course if necessary.