The Fed could hike in 50-bp increments until rates reach 2%, then assess how to proceed.
A half-point interest rate increase next week will set the pace for the Federal Reserve's sprint to neutral policy territory by summer to combat soaring inflation, according to current and former Fed officials.
Barring a significant shift in the economic outlook, the FOMC will raise the fed funds rate in 50-bp increments, twice as fast as typical, until rates are near 2.0%, the low end of the committee's estimate of neutral. At that point, officials will re-evaluate how much further to hike rates and at what pace, current and ex-officials say.
"They feel sufficiently behind the curve that they’ll probably be on 50 for a while -- I would guess at least two or three before throttling back," former Fed Vice Chair Alan Blinder told MNI.
Half-point hikes in May, June and July would take the target rate range to 1.75% to 2.0%. Eleven out of 15 FOMC members see neutral at 2.25% or 2.5% and want rates to get there by December. Investors are currently pricing in another 200 bps of rate increases this year after the quarter-point move in March.
BEHIND THE CURVE
Front-loading rate hikes is seen as a pragmatic move for a Fed playing catch-up on inflation and an economy with strong momentum and demand for labor, housing and goods that's far outstripping supply.
“I see an expeditious march to neutral by the end of the year as a prudent path,” San Francisco Fed President Mary Daly said last week. "My own starting point is that the case for a 50-bp adjustment is now complete. In my judgment, the economy is resilient, it can handle these adjustments.”
If the economy starts sputtering or inflation comes down fast, the Fed will feel less urgency to raise interest rates rapidly, current and former officials said. But a more likely scenario is one in which Russia's war on Ukraine and Covid lockdowns in China keep up pressure on prices even as confidence sags and growth slows.
Continued supply chain disruptions raise the likelihood of having to take interest rates above 2.5% to tame inflation, Dallas Fed research director Marc Giannoni told MNI last week. (See MNI INTERVIEW: Rates May Have To Exceed Neutral-Fed's Giannoni)
"Over the next eight or nine months, we'll see to what extent the adjustment that's already taken place will help move the economy in the right direction, or instead if we'll see further inflationary pressures and continued acceleration in demand, in which case we'll probably need to make some adjustments" to the fed funds path, he said in an interview.
IF EXPECTATIONS RISE
Worse, if inflation expectations move markedly higher as high inflation persists, the Fed's estimates of the neutral rate would rise as well, with hawkish implications for the path of policy.
Fed officials are comforted by the fact that forward-looking real rates are currently above zero, a signal that households and firms expect inflation to come down as interest rates rise.
Should expectations shift, the Fed may need to steel investors for even sharper hikes to stabilize prices.
But an equally important factor is whether the economy has already sunk into recession by next year, Blinder said.
"If there is a recession going on and the choice is between deepening the recession in order to get inflation below, say, 4% and living with 4% for a while in order to alleviate the recession, I wouldn't be surprised if they pick the latter."