Original Title: "A Question That Was Hard to Imagine a Few Weeks Ago: Will the Federal Reserve's Next Step be 'Rate Hikes'?"
Original Author: Dong Jing, Wall Street News
With the outbreak of the Iran conflict driving fuel prices soaring, a question that seemed almost unimaginable a few weeks ago has surfaced: Will the Federal Reserve's next move be a rate hike?
The financial markets are beginning to believe that this might happen. Traders in the derivatives market anticipate about a 25% probability of a rate hike this year. This shift in expectations highlights the direct impact of geopolitical conflicts on the global energy market and inflation outlook, prompting investors to reprice the Federal Reserve's policy path.
Although most economists expect the Federal Reserve to stay put at the upcoming meeting, the discussion of a rate hike is no longer taboo.
Analysts indicate that this dynamic not only breaks the market's general expectation that the Federal Reserve would continue to cut rates but also injects a high degree of uncertainty into the future direction of monetary policy, directly affecting bond yields and stock market risk appetite.
The Federal Reserve officials will hold a monetary policy meeting from March 17 to 18. The market will closely watch Powell's statements for any clues regarding the future interest rate path.
Inflation Concerns Resurface, Calls for Rate Hikes Emerge
The surge in oil prices has directly boosted inflation expectations, prompting some market participants to call for the Federal Reserve to take tightening action.
Chief Economist Carl Weinberg from High Frequency Economics believes that the Federal Reserve should raise rates at the upcoming meeting. He predicts that by this summer, oil prices will push the Federal Reserve's favored inflation measure—the Personal Consumption Expenditures Price Index (PCE)—up to an annual rate of 3.5%.
"The Federal Reserve's job is to minimize the risk of the worst outcomes, namely that prices accelerate beyond targets," Weinberg wrote in a report to clients.
He added:
"Even if the Federal Open Market Committee (FOMC) does not raise rates next week—we are currently not ruling out this possibility—officials will certainly discuss the issue, and we expect Mr. Powell to indicate this in his press conference."
Despite the emerging calls for rate hikes, most economists expect that the Federal Reserve will not take action in the short term. Given the uncertainties brought by the war, nearly all economists anticipate that the Federal Reserve will take a 'wait-and-see' approach.
Former Dallas Fed Chairman Robert Kaplan urged the central bank to remain patient. He stated, "I have a strange feeling that by the end of March, the situation will look different from now."
Former senior Federal Reserve official Vincent Reinhart also pointed out that most within the Federal Reserve still prefer to ease monetary policy, "but are in no rush to act." He believes, "The events in the Middle East have not changed that direction, just giving you more reasons to wait."
In addition, Deutsche Bank Chief U.S. Economist Matthew Luzzetti noted that a prerequisite for rate hikes is that the labor market must not only rebound but strengthen. However, the U.S. labor market has been struggling, averaging only 6,000 new jobs over the past three months.
Looking for Signals of Policy Shift
Although the Federal Reserve is likely to keep rates unchanged, economists will closely watch for any signals regarding the Federal Reserve's next steps.
James Egelhof, Chief U.S. Economist at BNP Paribas Securities, stated that he would observe whether Federal Reserve officials change their wording to indicate plans for rate cuts or hikes in the coming months.
The standard script for the Federal Reserve requires officials to "look through" oil price shocks or treat them as temporary because inflation associated with rising oil prices will not be persistent.
However, Egelhof pointed out that given the high inflation since 2021, which still exists five years later, there will be serious disagreements among Federal Reserve officials on whether to adopt this approach.
Comerica Chief Economist Bill Adams agrees that the Federal Reserve will signal an openness to either rate hikes or cuts. He stated:
"If inflation is at the 2% target level, concerns for the Federal Reserve about credibility and anchoring inflation expectations will be less than they are now."
Adams noted that policymakers might signal that they will use tools to prevent energy price shocks from translating into rising trend inflation rates. "This is a conditional willingness to raise rates, but not a signal for rate hikes in the near future."
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