MNI STATE OF PLAY (RPT): Fed Pencils In March Hike, Readies QT

Federal Reserve Chairman Jay Powell issued a clear warning Wednesday that interest rates will likely rise in March after nearly two years of being held near zero to battle the Covid-19 pandemic, adding the FOMC will also "significantly" reduce its balance sheet soon after rates lift off.

"The committee is of a mind to raise the federal funds rate at the March meeting, assuming that conditions are appropriate for doing so," Powell told reporters after a two-day FOMC meeting. Consumer inflation, at 5.7% by the Fed's preferred PCE measure, is "well above our 2% longer-run goal," and the labor market has made "remarkable progress" as job openings and wage growth hit record levels.

After completing its final set of asset purchases by early March, the Fed will begin its tightening cycle, Powell said, sending short end yields surging and equities reversing earlier gains.

No decisions were made at this week's meeting on how quickly the FOMC will increase its benchmark fed funds rate or whether a 50-bp hike was on the table for March, but Powell stressed the U.S. recovery is more vigorous than any other major nation's and faster than most past American ones as well.

INFLATION SITUATION 'WORSE'

"The economy is now much stronger, the labor market is far stronger, inflation is running well above our 2% target, much higher than it was (in 2015), and these differences are likely to have important implications for the appropriate pace of policy adjustments," Powell said. "Beyond that, we haven't made any decisions."

The extraordinarily strong fiscal and monetary response to the pandemic has left policymakers with "the relatively high class problems that come with that, which are high inflation and a labor shortage," Powell said.

With supply-side barriers for goods and workers persisting and the highly-contagious Omicron variant spreading quickly through the world, inflation risks are "still to the upside" and "probably slightly worse" than just a month earlier.

"There's a risk that the high inflation we're seeing will be prolonged, there's a risk that it will move even higher," he said. "We have to be in a position with our monetary policy to address all of the plausible outcomes."

RUNOFFS PLAN

The FOMC on Wednesday also codified its intention to use interest rates as its primary tightening tool, even as it plans to "significantly" reduce its USD8.7 trillion asset portfolio by capping reinvestments of maturing bonds.

"There's a substantial amount of shrinkage in the balance sheet to be done. That's going to take some time," Powell said.

A stronger recovery, higher inflation and a much bigger balance sheet means the Fed is "willing to move sooner than we did the last time and also perhaps faster," he said. But, "We think of the balance sheet as moving in a predictable manner, sort of in the background, and that the active tool meeting-to-meeting is not both of them, it's the federal funds rate."

The FOMC expects to continue discussions at the March and May meetings and on the details of the QT plan, he said.