Powell Signals More Hikes Coming, While Markets Detect Pivot
Chair Jerome Powell said the Federal Reserve will press on with the steepest tightening of monetary policy in a generation to curb surging inflation, while handing officials more flexibility on coming moves amid signs of a broadening economic slowdown.
Policy makers again raised the benchmark US interest rate 75 basis points on Wednesday to a range of 2.25% to 2.5% and said they anticipate “ongoing increases” will be appropriate.
Just how much depends on how the economy performs, the central bank chief said. He stepped away from the specific guidance on the size of upcoming hikes he previously gave, though he didn’t take another jumbo move off the table.
“While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data,” Powell said. “The labor market is extremely tight, and inflation is much too high.”
Despite the whatever-it-takes message, markets staged a powerful rally with the S&P 500 stock index rising 2.6%, keying off Powell’s remarks that the pace of rate increases would slow at some point and that policy won’t be pre-determined. Equities in Asia gained too.
But Powell didn’t flag a pivot to lower rates or even a pause, according to Fed watchers, who argued there was a disconnect between what the central banker said and how markets responded.
“We heard plenty of hawkish signals, including refusal to even contemplate that we are in a recession with strong job market gains and many references that restoring price stability is being prioritized over sidestepping a recession,” said Jonathan Millar, an economist with Barclays Plc. “Powell does not seem to be ruling out 100 or 75 basis-point hikes in September -- it’s data dependent.”
Central bankers are trying to tame the highest inflation in 40 years. Although the latest shift toward a more real-time approach to policy, Powell is trying to convey that the Fed will keep pushing borrowing costs higher as long as prices continue to jump too fast for comfort.
The strategy does raise risks of overshooting, however. Data lags behind what’s happening on the ground, while rate increases can take months to filter through the economy.
“The odds of a recession are 50-50,” said Lou Crandall, chief economist for Wrightson ICAP LLC. “The Fed’s tools are power tools. They’re not precision tools.”
Interest-rate markets are pricing a more benign hiking cycle than the Fed’s own June forecasts, which Powell pointedly said was the best current guide to the where officials see policy heading.
Investors are betting that rates will peak around 3.3% this year before the Fed starts cutting modestly in 2023. Officials in June projected rates at 3.4% at year-end and 3.8% in December 2023.
“By referencing the June Summary of Economic Projections he is not validating market pricing,” said Bloomberg’s chief U.S. economist Anna Wong. “The Fed is nowhere close to declaring victory over inflation.”
In the post-meeting press conference, Powell was clear about the committee’s bias. “Restoring price stability is just something that we have to do,” he told reporters.
“We do see that there are two-sided risks,” he said. “There would be the risk of doing too much and imposing more of a downturn on the economy than was necessary, but the risk of doing too little and leaving the economy with this entrenched inflation -- it only raises the cost.”
He said it wasn’t the committee’s intention to tip the economy into a recession, while noting that to achieve their 2% inflation goal slack would have to increase. That means unemployment would have to rise somewhat, while the economy would have to slow to below its full potential.
Walking that line between barely growing and recession is hard for any central bank to achieve. The economy becomes more vulnerable to shocks, and business sentiment can suddenly sour if profits start to vanish, triggering a deeper downturn.
Driving market sentiment is rising recession chatter spurred by anticipation that Thursday’s report on second-quarter US gross domestic product will show scant growth, and expectations of lower profits at major retailers.
Investors have a reflexive expectation that the Fed will pivot to easing -- maybe as early as next year -- to catch the economy if it falters, as it has done time and again over the past two decades. But in those years, inflation was contained and low, and often traveling below the committee’s target.
“The market is anchored to the playbook of the last two recessions,” said Derek Tang, an economist at LH Meyer in Washington. “The world is different now -- inflation is a lot higher.”
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