Federal Reserve Chairman Jerome H. Powell testifies before a House Financial Services hearing on “The Federal Reserve’s Semi-Annual Monetary Policy Report” on Capitol Hill in Washington, US, March 8, 2023.
Kevin Lamarque| Reuters
Federal Reserve Chairman Jerome Powell’s prepared speech to Congress this week lasted only a few minutes, but it changed everything.
In those remarks, the central bank leader laid out a new paradigm for how the Fed sees its policy path, one that will apparently see even higher interest rates for a longer period of time than previously thought.
The aftermath has forced the market, which has long anticipated the Fed blinking an eye in its inflation battle, to recalibrate its own views to more closely match policymakers who warned of a longer approach to interest rates.
“We obviously had a choreographed chorus of Fed speakers for two weeks that got us to that place,” said Art Hogan, chief market strategist at B. Riley Wealth Management. “It took Jay Powell, over the course of a very brief prepared statement and a Q&A, to elevate those expectations.”
As part of his mandated semiannual testimony on monetary policy, Powell spoke before the Senate Banking Committee on Tuesday and before the House Financial Services Committee the day after.
Going by appearances, markets had expected the Fed to raise its benchmark rate by 0.25 percentage point at its meeting later this month, then perhaps two more steps before stopping, ending at around 5.25%.
That changed after Powell’s appearance, in which he warned that if inflation data remains strong, he expects rates to “go higher than previously expected” and possibly faster than a quarter point at a time.
Markets are now strongly anticipating a half-point increase in March and the peak, or closing rate, will reach nearly 5.75% before the Fed is ready.
When the facts change
So what has changed?
Essentially it was the January inflation numbers plus signs that the labor market remains remarkably strong, despite the Fed’s efforts to slow it down. That caused Powell, who only weeks earlier had talked about “disinflationary” forces at play, shift gears and start talking hard about monetary policy again.
“He adapts to the data that comes in, which is what the entire board should be doing,” Hogan said. “If the facts change again with the February and March data, he will probably get flexible on that side and not push this too far to the point where they have to break something.”
Indeed, Powell said he will be keeping a close eye on a crucial set of upcoming data — Friday’s nonfarm payroll report, followed by next week’s look at consumer and producer price indices.
Goldman Sachs economists are sticking to their forecast for a quarter-point increase at the March 21-22 Federal Open Market Committee meeting, but admit it’s a “close call” between that and a half point.
Should the Fed need to veer in the more aggressive direction, Goldman warned in a client note that this could have market effects, with stocks selling “sharper” and downward pressure on commodities, plus upward pressure on the dollar.
Stocks plummeted again Tuesday and Thursday as investors became more nervous about the Fed’s future path. Thursday’s sell-off, however, caused a shift to the downside in terms of expectations for an increase of half a point this month, up 58% recently, according to an estimate by the CME Group.
Worry about the consequences
Powell was questioned this week about the Fed’s anti-inflation strategies.
Some more progressive legislators, such as Sen. Elizabeth Warren, D-Mass., and Rep. Ayanna Pressley, D-Mass., charged that the rate hikes will result in 2 million layoffs and disproportionately harm working-class families. Powell countered that inflation also affects those at the lower end of the income spectrum.
“This is what he should be doing,” Joseph Brusuelas, chief economist at consulting firm RSM, said of Powell’s shifting policy stances. “Jay Powell is a punching bag in Washington right now. He will take the blame for bringing about price stability. If he does it right, he will be revered in years to come. People will speak highly of him. ”
Brusuelas is among those who think the Fed should speed up its inflation battle with a rate hike of half a point.
However, he said policymakers could be swayed by a potentially softer jobs report and inflation data next week that reverses course and shows price increases are easing. Economists expect payrolls to have grown by 225,000 in February, according to Dow Jones, and there is widespread belief that January’s 517,000 increase will be revised downwards in this report, perhaps significantly.
“The economy is just too resilient right now,” Brusuelas said. “They need to create enough labor space to cool down the economy.”
Slack was not clear in this week’s Labor Department report on January job openings, which were outnumbered by a margin of 1.9 to 1.
Such data could prompt the Fed to tighten further, according to Nomura economists. The company said future actions could include adjustments to the Fed’s program to reduce its bond portfolio, with the option of eliminating the $95 billion monthly reduction limit currently in effect.
For now, markets will continue to price in higher rates.
Although Powell made a special point on Wednesday to emphasize that no decision has yet been made on the March rate hike, the markets essentially ignored him. Futures traders charged a closing rate of 5.625% later this year, well above levels before Powell spoke.