Fed Chair Jerome Powell has expressed his admiration for Fed Chair Paul Volcker, whose unprecedented raises in the fed funds rate broke the back of intractable inflation for decades to come. Despite the fierce 1980-82 recession, Volcker is universally admired. The stock market reached an inflation-adjusted nadir in 1982 and has trended upward from there. Economists recognize that short-term pain led to long-term gain.
Powell is faced with rising inflation. The quarter-point increase in the fed funds rate last week elicited a yawn from the markets, which love predictability.
**Powell Says Fed Will Consider More-Aggressive Interest-Rate Increases to Reduce Inflation**
**Bringing down inflation and avoiding recession will be ‘challenging task,’ says central bank leader**
**by Nick Timiraos, The Wall Street Journal, 3/21/2022**
**Federal Reserve Chairman Jerome Powell said the central bank is prepared to raise interest rates in half-percentage-point steps and high enough to deliberately slow the economy if it concludes such steps are warranted to bring inflation down...**
**The Fed raised its benchmark interest rate by one-quarter of a percentage point to a range between 0.25% and 0.5% last week, and officials penciled in a series of additional increases raising it to slightly below 2% at the end of this year and to around 2.75% next year.**
**Most Fed officials believe a neutral rate, assuming 2% inflation, is near 2.5%.**
**[** This is the overnight rate. That 2.5% yield is above the current 10 and 30 year Treasury yield and would invert the yield curve.
**“If we conclude that it is appropriate to move more aggressively by raising the federal-funds rate by more than [one-quarter of a percentage point] at a meeting or meetings, we will do so,” Mr. Powell said. “And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.”...** [end quote]
The Fed tried to raise the Fed funds rate in late 2018 but the markets had a hissy fit and he backed off. If he had stuck to his guns in 2018 (under ferocious political and market pressure which the Fed is supposed to be independent of) the current bubbles in stocks, bonds and real estate would not have formed – or at least would have moderated.
When the markets hear “restrictive” – well, that’s like a dark cloud moving in. “Neutral” would be far more restrictive than today’s ultra-loose financial climate. “Restrictive” takes interest rates higher than “neutral.”
Ultra-low interest rates are mirrored in ultra-low financial stress which leads to bubbles that pop.
Be careful out there. Returning from ultra-loose to neutral will stress the markets. Going past neutral to restrictive in order to control inflation will put the markets into a Volcker-like 1980-82 type regime. Study the charts and decide whether it’s better to hold through the volatility since the market may not return to its bubble level for many years.