Fed Chair Powell heads to Capitol Hill and has his hands full

U.S. Federal Reserve Chairman Jerome Powell speaks during a Senate Banking Committee hearing titled “Semiannual Monetary Policy Report to Congress” in Washington, U.S., March 3, 2022.

Tom Williams | Reuters

Federal Reserve Chairman Jerome Powell faced a big challenge in Congress: Convince lawmakers that he won’t bring down inflation and bring down the rest of the economy at the same time.

The markets wondered if he could pull it off. The mood has been upbeat in recent days, but that rush could change the other way if the central banker stumbles during his semi-annual monetary policy testimony this week.

“He has to thread the needle here with two messages. One of them is repeating some of his comments that there is some progress on inflation,” said Robert Teeter, head of investment policy and strategy at Silvercrest Asset Management.

“The second thing is really persistence in terms of the outlook for rates to stay high. It could repeat the message that rates are going to go up until inflation is clearly resolved,” Teeter added.

If he sticks to that stance, he could face some heat from the Senate Banking Committee on Tuesday and then from the House Financial Services Committee on Wednesday.

Democratic lawmakers, especially Powell, worried that the Fed’s commitment to fighting inflation risked dragging down the economy, especially those at the bottom of the wealth scale.

Slowly climb out of the blocks

The Fed has raised its benchmark interest rate eight times over the past year, most recently by a ninety percentage point increase early last month that pushed the overnight borrowing rate to a target range of 4.5%-4.75%.

Markets also fear that the Fed wants to keep inflation low and that it will go too far. The central bank’s slow start to tackle the rising cost of living has fueled fears that it may not be able to lower prices without triggering at least a modest recession.

“Inflation is a dangerous problem. It’s made worse by the Fed’s failure to recognize it in 2021,” said Komal Sri-Kumar, president of Sri-Kumar Global Strategies.

Sri-Kumar believes the Fed needs to attack faster and more aggressively — for example, by raising 1.25 percentage points in September 2022 when consumer price index inflation is at 8.2% annually. Instead, the Fed began tapering rate hikes in December.

Now, he said, the Fed could raise its funds rate to around 6% before inflation subsides, and that would hurt the economy.

“I don’t believe in this no-landing scenario,” Sri-Kumar said, referring to the theory that the economy will see neither a “hard landing” nor a “soft landing,” which is considered a sharp recession. have a shallow decline.

“Yes, the economy is strong. But that doesn’t mean you’re going to get through without a recession at all,” he said. “If you have a no-holds-barred scenario, then you’re accepting 5% inflation, and that’s politically unacceptable. It should work to reduce inflation, and because the economy is so strong, it can be achieved. But the longer the delay in the recession, the deeper it will be.”

“Continuous growth” is ahead

For his part, Powell must find a footing between competing views on policy.

The Fed released its monetary policy report to Congress on Friday, which included Powell’s testimony in the often-used language that policymakers expect “steady increases” in rates.

Krishna Guha, head of global policy and central bank strategy at Evercore ISI, said in a client note that the chair “may have a clear and measurable tone.” Powell notes the “resilience of the real economy” while warning that inflation data has risen and the road to recovery will be “long and difficult.”

However, Guha said Powell’s rate hike of half a point or 50 basis points later this month, which some investors fear, is unlikely. Market prices on Monday indicated a roughly 31% chance of a big move, according to data from CME Group.

“We think the Fed will hike 50 bps in March only if inflation expectations, wage and services inflation rise dangerously high and/or earnings data is so strong,” Guha wrote. “The Fed cannot end a meeting any further from its destination than before the meeting began.”

In the future, interpretation of the data will be difficult.

Core inflation may actually show a sharp decline in March, as energy price increases over the past year distort year-on-year comparisons. The Cleveland Fed’s tracker shows that all-items inflation fell to 5.4% in March from 6.2% in February. However, excluding food and energy, core inflation is forecast to increase from 5.5% to 5.7%.

Guha Powell said the Fed could raise the end point of rate hikes — the “terminal” rate — to a range of 5.25-5.5%, or about a quarter of a point higher than policymakers expected in their December economic forecasts.

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