The Federal Reserve knows it needs to demonstrate that it can get inflation under control — and fast.
What’s happening: Pressure on the Fed has increased after the most recent batch of government data showed that annual inflation jumped to 8.6% in May, which was higher than economists had expected. Investors now believe the Fed will raise interest rates by three-quarters of a percentage point at the conclusion of its policy meeting on Wednesday. That hasn’t happened since 1994.
« Definitely, we’re going to see 75 basis points after this meeting », Bill Dudley, the former president of the New York Federal Reserve Bank, told CNN. But interest rates aren’t the only tool at the Fed’s disposal. It’s also beginning the process of shrinking its massive balance sheet after buying up trillions of dollars in financial assets during the Covid-19 pandemic.
« Should the economy remain overheated and inflation remain stubborn, that is part of the policy matrix », Joseph Brusuelas, chief economist for RSM US, told CNN Business. He thinks that Fed Chair Jerome Powell should make clear that, if necessary, the Fed could offload bonds at a quicker pace and start selling mortgage-backed securities, which could help ease pressure in the housing market. So-called « shelter » costs are rising at the fastest rate in decades. That’s concerning, since as a source of inflation, it tends to stick around.
« Filling a tank of gas, people can look at that and say, ‘Maybe next week will be cheaper' », said Ronald Temple, co-head of multi-asset and head of US equity at Lazard Asset Management. « Rent is a locked in expense for a year or two. »
But ramping up balance sheet reduction — a process known as « quantitative tightening », or QT — also carries risks.
