Fed’s Hammack backs gradual hikes, says inflation is worsening

The Fed “has been missing on the inflation mandate for years.” That was the assessment of Cleveland Federal Reserve (Fed) President Beth Hammack on Thursday, although she credited the central bank with doing good work on the “job side of the mandate,”.

Although recent data point to inflation heading in the wrong direction, Hammack favoured gradual interest rate adjustments. She nevertheless acknowledged that the Fed “needs to move rates higher to get to restrictive rate policy.”

Main points:

Employment mandate performance remains very strong at the Fed

For years, the Fed has fallen short of its inflation mandate

Inflation is heading in the wrong direction, according to the latest data

High inflation partly reflects genuine demand pressures

Lowering inflation requires a shift to restrictive monetary policy

Concerned that an inflationary mindset could take hold in the economy

Approaches every FOMC meeting with an open mind

Favours smaller Fed rate adjustments at a steadier pace

Reaching a restrictive policy stance requires the Fed to raise rates further

Does not view the Fed as behind the curve, but would consider stronger action if it fell behind

The economy has time to adjust when rate increases are smaller and steadier

Price pressures are broadening, recent inflation figures indicate

Describes the labour market as static rather than healthy, given its lack of dynamism

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Federal Reserve: Key Questions

Federal Reserve Policy and Its Effect on the US Dollar

2% is the Fed’s inflation target. The Federal Reserve (Fed) sets US monetary policy under a dual mandate: stable prices and full employment. Interest rate adjustments are its main means of pursuing those objectives. If prices rise too rapidly and inflation exceeds that target, the Fed increases interest rates. Borrowing then becomes more expensive across the economy. Higher rates strengthen the US Dollar (USD) by making the US a more appealing destination for international investors’ funds. Conversely, inflation below 2% or an excessively high unemployment rate may prompt the Fed to cut interest rates. By encouraging borrowing, such cuts put downward pressure on the US currency.

The Fed’s Monetary Policy Meeting Schedule

Eight policy meetings take place each year at the Federal Reserve (Fed). At these meetings, the Federal Open Market Committee (FOMC) reviews the economy and decides monetary policy. Twelve Fed officials attend the FOMC: the seven Board of Governors members, the president of the Federal Reserve Bank of New York and four presidents drawn from the other eleven regional Reserve Banks. Those four serve rotating one-year terms.

Quantitative Easing (QE): Implications for USD

During extreme conditions, Quantitative Easing (QE) is a policy option available to the Federal Reserve. It sharply expands the supply of credit when the financial system has become stalled. This unconventional measure is deployed in crises or periods of exceptionally low inflation. During the Great Financial Crisis in 2008, it was the Fed’s preferred tool. Under QE, the Fed prints additional Dollars to purchase high-grade bonds from financial institutions. The US Dollar typically weakens as a result.

Quantitative Tightening (QT): Implications for the US Dollar

The US Dollar generally benefits from quantitative tightening (QT), which reverses QE. Under QT, the Federal Reserve ceases bond purchases from financial institutions. It also allows its existing bonds to mature without reinvesting the principal in new bonds.