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Fed Chair Powell leaves optionality open on rate hikes, balance sheet

Yahoo Finance's Brian Cheung recaps what to expect in 2022 after Fed Chair Jerome Powell's press conference, including the amount of proposed interest rate hikes, taming inflation, and the Fed balance sheet.

Video transcript

ADAM SHAPIRO: All right, the last question at the press conference was asked by our very own Yahoo Finance Fed correspondent, Brian Cheung. And Brian, you were hitting him-- or hitting him-- you were asking him for some clarity on these rate increases. Tell us more.

BRIAN CHEUNG: Yeah, well, my question to him at the very end, last but certainly not least, was really about the idea of whether or not the Fed wanted to be gradual with its moves this year. And the Fed chairman shying away from wanting to describe it as any one or singular adjective. And the reason for that is because the Fed wants to give itself optionality. And I think that's the word I would use to describe most of what the Fed's been trying to do over the course of this meeting.

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And that's because of two things. First of all, optionality on rate hikes themselves, obviously, the Federal Reserve had messaged in December that it was intent on raising interest rates probably around three times over the course of 2022. But the Fed chairman said that inflationary pressures got slightly worse since that meeting. So if anything, directionally, we know the Fed would probably opt to do more interest rate hikes. But he didn't want to say or commit to 50 basis point hikes versus 25 basis point hikes or hikes in consecutive meetings. Keep in mind the Fed has meetings every six weeks. So it remains to be seen exactly how the Fed is going to do this on the interest rate front.

But I would say optionality was also the theme on the balance sheet side of things as well. In that answer that he had to me, he was kind of emphasizing what he had told previous questioners over the course of the press conference, which is, look, at the end of the day, they released these principles for how the Fed after March would start to think about perhaps allowing its $9 trillion balance sheet to start to shrink.

Now the Fed said, for example, that it would primarily want to do this and favor treasuries over agency mortgage-backed securities, that they would want to do this by not reinvesting the principal for maturing securities that will simply roll off of the balance sheet. That's got a lot of questions as to whether or not the Fed would want to, for example, actively sell its agency mortgage-backed securities in the open market if it wanted to roll down the balance sheet quicker.

Now the Fed chairman didn't say they were going to do that. He just merely said that the principles that they published today, which were fairly boilerplate, were just a beginning and a starting point for that. But if you read the very first sentence of that statement, it says the Federal Reserve wants to significantly reduce its balance sheet. So make of that what you will. Maybe the Fed at some point later down the line will opt to get more aggressive by instead of passively, maybe more actively allowing its balance sheet to shrink. So all very interesting things within the context of what's going on here.

EMILY MCCORMICK: Brian, I'm wondering, as you listened to Fed Chair Jerome Powell's press conference, what was your big takeaway on how the Fed and how Powell specifically is thinking about inflation? Because I think one thing that really stood out to me was when he said he was inclined to raise his own core PCE estimate for inflation for 2022 by a few tenths of a percentage point. So what were your big takeaways?

BRIAN CHEUNG: Yeah, well, I think obviously inflation is the big thing that the Fed chairman is trying to look at because that is the onus for the Fed wanting to tighten its policy, right? On the labor market side of things, which is the other side of its dual mandate, the Fed chairman said that essentially most of the members of the FOMC feel like they're at maximum employment, which is the green light trigger for them to start normalizing policy.

Now, on the inflationary front, what's interesting and going to be a very difficult question for the Fed is there's a lag to monetary policy. Even after the Fed starts to raise interest rates it shouldn't be expected that in the first Consumer Price Index Report or PCE report that we'll get after that, that we'll start to see inflationary numbers start to fall. Now that's important because the Fed needs to know that it could be a few months after they start to tighten rates that you'll start to see the impact on inflation, which means the Fed could perhaps over tighten, but then it could also work in the other way.

If the inflationary numbers continue to remain high and the Fed is only going in a slower increment, the Fed might not realize that it's actually tightening too slow until many months into the process. So for the Fed chairman, he emphasized pretty much in that last answer to me that this is going to be a very interesting year 2022 for the Fed to assess the way by which it's going to tighten and the interaction of that between that, the monetary policy and ultimately, where prices go, which I think is a reason why thematically, as I just explained, optionality is really going to be the key for the Fed on both interest rates and their balance sheet.