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U.S. monetary policy is perhaps 225 basis points tighter than the restriction triggered by interest-rate hikes, as market yields were lifted even further by balance-sheet reduction and forward guidance, San Francisco Fed researchers said in a report Monday.
The FOMC's September rate increase to 3%-3.25% was the equivalent of an effective rate of at least 5.25% according to a proxy measure the authors created. The proxy rate uses a dozen variables such as Treasury yields, mortgage rates and borrowing spreads, and shows investors responded to guidance about rate increases and tapering asset purchases.
"U.S. monetary policy tightened sooner and more sharply than has been generally recognized," according to work by San Francisco Fed economists Andrew Foerster and Zinnia Martinez. Their co-authors were PhD student Jason Choi and Taeyoung Doh of the Kansas City Fed.
Their conclusion echoes arguments of several FOMC members in response to criticism the Fed was slow to react to the inflation surge as Covid restrictions eased. The Fed last week hiked another 75bps to 3.75%-4% and Chair Powell said the terminal rate is likely higher than people were expecting as inflation remains too high. The Fed didn't raise its near-zero policy rate until a quarter-point move March, and Powell earlier called inflation transitory.
The proxy funds rate had moved off the zero lower bound four months before the Fed boosted the official rate in March, the authors found. "Since late 2021, monetary policy has been substantially tighter than the federal funds rate indicates," according to the new paper.
Even with the higher proxy rate, inflation remains top of mind. Core PCE is running at 5.1% while headline CPI inflation is 8.2%. FOMC officials may clash at the December meeting over whether to slow the pace of interest rate hikes despite persistently high readings for key inflation measures and a strong job market, former Richmond Fed research director John Weinberg told MNI.
Interpreting recent policy moves against the past and even tools like the Taylor rule have become more nuanced since the introduction of forward guidance as early as 2003 and QE in 2008, the authors suggested in the paper.
Source: San Francisco Federal Reserve
Why MNI
MNI is the leading provider
of intelligence and analysis on the Global Fixed Income, Foreign Exchange and Energy markets. We use an innovative combination of real-time analysis, deep fundamental research and journalism to provide unique and actionable insights for traders and investors. Our "All signal, no noise" approach drives an intelligence service that is succinct and timely, which is highly regarded by our time constrained client base.Our Head Office is in London with offices in Chicago, Washington and Beijing, as well as an on the ground presence in other major financial centres across the world.