It seems like the right time to experiment with a 200bps (or more) hike was 6+ months ago. I don't really understand how people see the Fed as credible at all on inflation given the now long track record of not taking inflation seriously. The destruction of their reputation for maintaining price stability seems to be a FAIT accompli...
Still, I'm glad to see at least some folks finally on board with faster rate hikes.
Shouldn’t they do it just for the data point? Will we never know for sure the effect of a rapid rate hike? Go for it. If it’s more effective, we should no, if not, we’ll know not to do it again. One risk to inform all the future.
Thank you for that explanation Noah. Your posts are always very informative!
I understand how the break evens is the bond markets prediction of inflation. But they’ve been under the actual inflation for the past several months right?
They’ve been nowhere close to the 9% cpi. It’s possible the movement in breakevens are a lot smoother than actual CPI numbers or maybe they’re just not as reliable as we may think.
The Fed Guy on Odd Lots podcast was talking about how he doesn’t really look at the bond market as tea leaves. He believes there’s too many bank regulations and other reasons why people buy and sell bonds. I hadn’t heard that view before.
I think we should never overlook the fact that we're all subject to incentives. Going up 200 basis points and then having to back off and go down by 50 is a politically costly and embarrassing reversal in a way that a succession of insufficient increases isn't. Ideally this wouldn't factor into the reasoning of the Fed but while I can imagine individuals overcoming this tendency I don't see a way a committee trying to reach consensus could plausibly overcome it.
I would love to hear your opinion on the Fed's handling of the balance sheet because that seems to be the most questionable aspect to me. Why keep expanding the balance sheet for months as they are also giving guidance that rate hikes are coming? Why keep buying so much MBS for so long after it became apparent we weren't about to have another housing market freeze? Wouldn't allowing a faster run off of holdings or even selling holdings, especially longer dated holdings, help keep a more upward sloping yield curve and not dampen loan activity and promote a softer landing? All of the arguments I've read have basically been just to promote a smoother Treasury market which is pretty weak in my mind. Obviously chaos in Treasuries would be bad but most of those are such minor changes that it's hard to believe that they would result in chaos.
'we might see a really big rate hike a few months down the line' - certainly, since the diagnosis is wrong and the prescripted medicine does not work on greedflation.
Another topic that seems worth discussing is whether a central bank should merely deliver what is expected, which they typically do via forward guidance even at the last moment they have to whisper that to the WSJ, so has not to surprise markets. If the goal of policy is to alter future expectations, why is forward guidance useful, particularly in a cycle where rates are moving as opposed to staying on hold, where forward guidance might help a bit, although its benefits are probably exagerated. In order to alter expectations, would not there be value in surprising markets, creating heighted uncertainty, higher risk premium ect?
You have to remember that powell and company are bureaucrats. They are more concerned with doing the right political thing than the economic one. After all, their pay and pension are relatively safe.
The problem with fast hikes is that the Fed can over-react, doing often very substantial harm. Most likely, a big part of the inflation problem is the Fed over-reacting to the brief liquidity crisis at the start of the pandemic and running a record M2 print. It will not help for them to over-react in the opposite direction, especially since the current bout of inflation is a global phenomenon and so not plausibly primarily driven by Fed monetary policies.
I also think it's relevant that the 2yr-10yr spread shows the market thinks the Fed is *already* on the path to over-reaction.
Powell's finger is hovering over the return key, his eyes are closed, he takes a deep breath, and he hits F9 by mistake.
Well that was a relief.
Market turmoil would ensue. Bonds, stocks, everything.
The commodities likewise.
Currency markets would just go dollar up everything else down. Emergency meetings in central banks the world over to match Powell and save their currencies.
I feel like a lot of how folks will react has more to do with messaging and publicity as opposed to the policy itself (at least with regards to hiking rates).
Endlessly repeat that they got it wrong and steeper rates are the way to go -- and the market may react rather favorably. Talk as if 75bps are coming up and them go bonkers with a 200bp one and there will be short-term chaos.
Because the economy is a complex system with many unknown and unknowable feedbacks, I believe that the incremental approach to rates adjustments is appropriate. Too large a change in the policy rate, might trigger a mathematical catastrophe.
Seems like there is a second (third?) order question here. A 200bp increase right now would shock the market because the market assumes that the Fed goes in steps, so a 200bp increase implies future significant increases and also shows that the Fed "really means it" this time. But if the Fed started regularly just jumping to their eventual target, a 200 BP jump wouldn't be all that surprising and wouldn't imply future 200 BP jumps so would be less shocking to the market.
This is possibly an argument against doing it (or at least doing it regularly). By generally working in small increases, the Fed gets to save their bog increases "in case of emergency."
It seems like the right time to experiment with a 200bps (or more) hike was 6+ months ago. I don't really understand how people see the Fed as credible at all on inflation given the now long track record of not taking inflation seriously. The destruction of their reputation for maintaining price stability seems to be a FAIT accompli...
Still, I'm glad to see at least some folks finally on board with faster rate hikes.
Shouldn’t they do it just for the data point? Will we never know for sure the effect of a rapid rate hike? Go for it. If it’s more effective, we should no, if not, we’ll know not to do it again. One risk to inform all the future.
He had a much longer way to go though, no? Jumping to optimal.
Thank you for that explanation Noah. Your posts are always very informative!
I understand how the break evens is the bond markets prediction of inflation. But they’ve been under the actual inflation for the past several months right?
They’ve been nowhere close to the 9% cpi. It’s possible the movement in breakevens are a lot smoother than actual CPI numbers or maybe they’re just not as reliable as we may think.
The Fed Guy on Odd Lots podcast was talking about how he doesn’t really look at the bond market as tea leaves. He believes there’s too many bank regulations and other reasons why people buy and sell bonds. I hadn’t heard that view before.
I think we should never overlook the fact that we're all subject to incentives. Going up 200 basis points and then having to back off and go down by 50 is a politically costly and embarrassing reversal in a way that a succession of insufficient increases isn't. Ideally this wouldn't factor into the reasoning of the Fed but while I can imagine individuals overcoming this tendency I don't see a way a committee trying to reach consensus could plausibly overcome it.
I would love to hear your opinion on the Fed's handling of the balance sheet because that seems to be the most questionable aspect to me. Why keep expanding the balance sheet for months as they are also giving guidance that rate hikes are coming? Why keep buying so much MBS for so long after it became apparent we weren't about to have another housing market freeze? Wouldn't allowing a faster run off of holdings or even selling holdings, especially longer dated holdings, help keep a more upward sloping yield curve and not dampen loan activity and promote a softer landing? All of the arguments I've read have basically been just to promote a smoother Treasury market which is pretty weak in my mind. Obviously chaos in Treasuries would be bad but most of those are such minor changes that it's hard to believe that they would result in chaos.
'we might see a really big rate hike a few months down the line' - certainly, since the diagnosis is wrong and the prescripted medicine does not work on greedflation.
Why not use capital requirements?
Another topic that seems worth discussing is whether a central bank should merely deliver what is expected, which they typically do via forward guidance even at the last moment they have to whisper that to the WSJ, so has not to surprise markets. If the goal of policy is to alter future expectations, why is forward guidance useful, particularly in a cycle where rates are moving as opposed to staying on hold, where forward guidance might help a bit, although its benefits are probably exagerated. In order to alter expectations, would not there be value in surprising markets, creating heighted uncertainty, higher risk premium ect?
You have to remember that powell and company are bureaucrats. They are more concerned with doing the right political thing than the economic one. After all, their pay and pension are relatively safe.
The problem with fast hikes is that the Fed can over-react, doing often very substantial harm. Most likely, a big part of the inflation problem is the Fed over-reacting to the brief liquidity crisis at the start of the pandemic and running a record M2 print. It will not help for them to over-react in the opposite direction, especially since the current bout of inflation is a global phenomenon and so not plausibly primarily driven by Fed monetary policies.
I also think it's relevant that the 2yr-10yr spread shows the market thinks the Fed is *already* on the path to over-reaction.
How about a live experiment?
Powell's finger is hovering over the return key, his eyes are closed, he takes a deep breath, and he hits F9 by mistake.
Well that was a relief.
Market turmoil would ensue. Bonds, stocks, everything.
The commodities likewise.
Currency markets would just go dollar up everything else down. Emergency meetings in central banks the world over to match Powell and save their currencies.
World recession follows.
Glad he missed and hit f9 by mistake.
I feel like a lot of how folks will react has more to do with messaging and publicity as opposed to the policy itself (at least with regards to hiking rates).
Endlessly repeat that they got it wrong and steeper rates are the way to go -- and the market may react rather favorably. Talk as if 75bps are coming up and them go bonkers with a 200bp one and there will be short-term chaos.
Because the economy is a complex system with many unknown and unknowable feedbacks, I believe that the incremental approach to rates adjustments is appropriate. Too large a change in the policy rate, might trigger a mathematical catastrophe.
Seems like there is a second (third?) order question here. A 200bp increase right now would shock the market because the market assumes that the Fed goes in steps, so a 200bp increase implies future significant increases and also shows that the Fed "really means it" this time. But if the Fed started regularly just jumping to their eventual target, a 200 BP jump wouldn't be all that surprising and wouldn't imply future 200 BP jumps so would be less shocking to the market.
This is possibly an argument against doing it (or at least doing it regularly). By generally working in small increases, the Fed gets to save their bog increases "in case of emergency."
Good piece, thanks!