Fed's Brainard: Prepared to take stronger action if inflation and inflation expectations require it

Fed Vice Chairwoman Lael Brainard said on Tuesday that the Fed is prepared to take stronger action if the inflation outlook and inflation expectations indicators suggest the need for such action, reported Reuters. The combined impact of rate hikes and balance sheet reduction will bring monetary policy to a more neutral position later this year, she continued, noting that once monetary policy is more neutral, the extent of additional tightening will depend on the evolving outlook for inflation and employment. 

The Fed will tighten monetary policy "methodically" through a series of rate hikes, Brainard said, and will start reducing the size of the balance sheet at a rapid pace as soon as the May meeting. She said she expects the balance sheet to shrink at a considerably more rapid pace than during the previous recovery. 

On inflation, Brainard noted that it is much too high and subject to upside risks. Meanwhile, she noted that Russia's invasion of Ukraine and recent Covid-19 lockdowns in China are likely to extend supply chain bottlenecks and also pose downside risks to growth. 

Brainard said that she is watching the yield curve and other data for suggestions of increased downside risks to activity, before noting that longer-term inflation expectations remain within normal ranges. She added that she is monitoring the extend of the rotation from goods demand into services and whether the service sector can absorb this without inflationary pressures being sparked. 

Finally, Brainard acknowledged that the burden of inflation on lower-income households, those with more household members or older household heads is not necessarily captured in the official consumer price indices. 

Market Reaction

Brainard's remarks appear to have stoked a hawkish reaction in US markets, with traders citing her warning that rapid balance sheet reduction could begin in as soon as May. US 10-year bond yields have jumped a few bps in the last few minutes to  back above 2.50% and are eyeing a test of multi-year highs set back on 28 March at 2.557%. 2-year yields also jumped a few bps to just under 2.50%. Of course, that means the 2s/10s spread is no longer inverted and goes to show that Fed policy can fight yield curve inversion by sounding more hawkish on the QT front. 

Stocks haven't liked it. The S&P 500 was trading 0.2% higher in the 4590s prior to Brainard's remarks but is now down over 0.5% on the day and trading in the 4550s.