Federal Reserve Chairman Jerome H. Powell on Capitol Hill in Washington, DC, March 8, 2023. Testifying before a House Financial Services hearing on the Federal Reserve’s Semiannual Monetary Policy Report.
Kevin Lamarck | Reuters
Federal Reserve Chairman Jerome Powell’s speech to Congress this week took only a few minutes, but it changed everything.
In those remarks, the central bank chief set a new paradigm for how the Fed views its policy path, which looks set to see higher interest rates for longer than previously thought.
The fallout has forced the Fed, which has long looked to the market to blink in the fight against inflation, to reexamine its approach to be more in line with policymakers who have long warned of a higher outlook for interest rates.
“We had a choreographed chorus of Fed speakers for two weeks that got us there,” said Art Hogan, chief market strategist at B. Riley Wealth Management. “Jay Powell needed to raise those expectations during a brief prepared statement and question-and-answer session.”
Powell spoke before the Senate Banking Committee on Tuesday as part of his semiannual testimony on monetary policy and then before the House Financial Services Committee the next day.
Based on the outlook, markets expected the Fed to raise its benchmark interest rate by 0.25 percentage points at its meeting later this month, followed by two more steps before stopping, with an endpoint of around 5.25%.
That changed after Powell’s appearance, during which he warned that if inflation data remains strong, he expects rates to be “higher than previously expected” and at a rate faster than a quarter point at a time.
Markets now strongly expect a half-point hike in March and a peak or terminal rate of 5.75% before the Fed ends.
When the facts change
So what has changed?
For the most part, these January inflation data and signs that the labor market remains fairly strong despite the Fed’s efforts to moderate it. That prompted Powell, who had talked about “disinflationary” forces in the game a few weeks ago, to shift gears and start talking tougher about monetary policy again.
“It’s adapting to the data that’s coming in, and that has to be done across the board,” Hogan said. “If the facts change again with the February and March data, he can be flexible about that and not push it to the point where he has to break something.”
Indeed, Powell said he will be closely watching a key set of data ahead — Friday’s nonfarm payrolls report, followed by a look at the consumer and producer price indexes next week.
Goldman Sachs economists are sticking to their forecasts for a quarter-point hike at the March 21-22 Federal Open Market Committee meeting, but admit it’s a “close call” between that and half a point.
If the Fed were to lean toward a more aggressive stance, Goldman warned in a client note, it could affect the market, with stocks selling “sharply” and putting downward pressure on commodities, as well as upward pressure on the dollar.
Worrying about consequences
Powell faced some questions this week about the Fed’s inflation-fighting strategy.
Sen. Elizabeth Warren, D-Mass. And some progressive lawmakers, like U.S. Rep. Ayanna Pressley, have charged that the tariff hikes will put 2 million out of a job and disproportionately hurt working families. Powell argued that inflation is also hitting those at the bottom of the income spectrum.
“He has to do it,” Joseph Brusuelas, chief economist at consulting firm RSM, said of Powell’s evolving policy stance. “Jay Powell is the punching bag in Washington right now. He’s going to be blamed for price stability. If he does it well, he’s going to be respected for years to come. People are going to speak highly of him.”
Brusuelas is among those who think the Fed should raise its fight against inflation by half a percentage point.
However, he said policymakers could be prompted by a softer jobs report and inflation data next week, which would change course and signal a slowdown in price growth. Economists expect payrolls to have risen by 225,000 in February, according to Dow Jones, and January’s increase of 517,000 is expected to be significantly lower in that report.
“The economy is too resilient right now,” Brusuelas said. “They need to produce enough labor to cool the economy.”
This week’s Labor Department jobs report for January showed no sign of easing, outpacing jobless workers by a 1.9-to-1 margin.
According to Nomura economists, such data could prompt the Fed to tighten further. The firm said future actions could include adjustments to the Fed’s bond portfolio reduction program, one option of which is to remove the current $95 billion monthly drawdown limit.
Currently, the markets continue to price in higher prices.
While Powell emphasized on Wednesday that no decision had yet been made on a March rate change, markets ignored him. Traders in the futures market pegged the terminal rate at 5.625% later this year, well above the level before Powell spoke.
