By Joy Wiltermuth
Federal Reserve Chairman Jerome Powell has begun talking about a “softish landing” for the economy as the central bank squares off against high inflation by raising rates and cutting its nearly $9 trillion balance sheet.
But what if Powell instead retraces the policy steps of former Fed Chair Paul Volcker from 40 years ago in a quest to stamp out inflation, for good, even at the cost of an economic recession?
That’s a scenario that Societe Generale’s global quantitative research team studied in a client note Tuesday, now that an “inflation-fighting impulse” is in the air. The team, led by the French bank’s head of North American quant research Solomon Tadesse, concluded that it could take another 9.25% (see chart) of monetary-policy tightening to stamp out inflation, should the Fed adopt a sole focus on containing inflation.
“Given that rates have already been tightened by 2.5%, another 9.25% of monetary tightening might be expected via policy rate hikes and an aggressive QT program,” the team wrote.
Specifically, that could mean a policy rate increase of 4.5% overall, plus a roughly $3.9 trillion reduction of its balance sheet , known as quantitative tightening, or “roughly equivalent to the net growth of the Fed’s balance sheet during the pandemic.”
On the flip side, if the Fed goes after a “growth-conscious tightening” cycle, one that aims to avoid a hard landing, the team sees little room left to tighten. In that scenario, policy is seen as peaking after 3% additional tightening, broken down into $1.8 trillion in balance-sheet reduction and only a further 25 to 50 basis points of rate hikes.
Stocks plunged Wednesday, with the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.23% tumbling nearly 1,200 point s. That added to a sharp fall this year for equities as the Fed has looked to cool inflation near levels last seen in the early 1980s. The S&P 500 index /zigman2/quotes/210599714/realtime SPX +0.36% was down 17.7% in 2022 through Wednesday, while the Dow was 13.3% lower and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +0.35% was down 27% for the same stretch.
“Should supply-chain bottlenecks ease over time, the degree of monetary tightening needed to contain inflation through demand destruction could turn out to be lower,” the Societe Generale team wrote.