Fed Reaffirms Early Tightening... "Significant Balance Sheet Reduction Appropriate" (Update)

Despite Hawkish Remarks, Market Relieved: "No Surprise"

[Image source=Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina] The U.S. central bank, the Federal Reserve (Fed), indicated that it will accelerate the pace of tightening starting with the Federal Open Market Committee (FOMC) meeting in March to lower inflation. It plans to raise the benchmark interest rate faster than the original roadmap and also engage in quantitative tightening (QT) such as balance sheet reduction. However, this direction does not deviate from the level the market had anticipated.

According to the minutes of the January FOMC meeting released by the Fed on the 16th (local time), most participants expressed the opinion that the federal funds rate target range should be raised faster than in 2015. Most participants mentioned, "If inflation does not come down as expected, it would be appropriate to remove policy accommodation at a faster pace than currently anticipated."

Some participants also pointed out that the Fed’s loose monetary policy could pose risks. They argued that rapid normalization of monetary policy is urgent.

The Wall Street Journal (WSJ) analyzed that this suggests the possibility of consecutive rate hikes starting with the regular FOMC meeting on March 15-16, followed by increases in May and June. The market expects the first rate hike to occur in March.

Balance sheet reduction is also expected to begin earlier than initially anticipated. Among the participants on this day, many confirmed the opinion that "the Fed currently holds too many assets" and that "a substantial reduction is appropriate." Most participants agreed that balance sheet reduction should start after the first rate hike. Additionally, some members argued that this timing should be moved up.

The Fed’s assets, which were $4.1 trillion in January 2020, surged to about $8.8 trillion due to bond purchases to supply liquidity to the market during the COVID-19 pandemic. Wall Street experts view that reducing the Fed’s assets by $500 billion has a similar effect to raising interest rates by 0.25 percentage points.

The January meeting repeatedly confirmed concerns about inflation. Local media reported that the word "inflation" appeared as many as 73 times in the released summary. Many participants expressed concern that recent inflation indicators significantly exceed the Fed’s long-term target and that stronger and more persistent inflation than expected has been confirmed.

Following the FOMC, the U.S. January Consumer Price Index (CPI) showed a 7.5% surge, the highest in 40 years. Despite the Fed’s repeated messages to curb inflation by all means, the rate of price increase was even higher than in December last year. In response, James Bullard, president of the Federal Reserve Bank of St. Louis and a prominent hawk within the Fed, argued that the benchmark interest rate should be raised by 1 percentage point before July to tackle inflation. For this, a "big step" of raising rates by 0.5 percentage points at once is essential.

However, voices advocating caution are also strong. Mary Daly, president of the San Francisco Fed, and Esther George, president of the Kansas City Fed, recently indicated a negative stance on a 0.5 percentage point hike in public appearances. They emphasize cautious and gradual rate increases based on data.

Experts believe that divisions within the Fed over the pace of tightening will continue until the February inflation indicators are released. Ultimately, the February CPI and employment data released before the March FOMC will be key. Fed Chair Jerome Powell has also been reserved in public remarks since the January FOMC. WSJ noted, "More precise direction depends on Chair Powell’s statements."

After the minutes were released, the market did not show significant volatility. The New York stock market, which had been declining due to concerns over the Ukraine invasion, actually reduced its losses immediately after the minutes were published. This appears to reflect the judgment that the Fed’s tightening message in the minutes did not differ significantly from market expectations. Economic media CNBC reported, "There was no additional surprise."

This content was produced with the assistance of AI translation services.