After lifting interest rates by 5 percentage points since March last year the Fed this month paused to assess the effects of its actions but left a strong indication that interest rates would continue rising because inflation was too high and there would be some damage.
“Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions,” he said.
“Softer labor market conditions” would include rising layoffs and a higher unemployment rate. Fed officials, though, have said they hope to curb inflation mainly by reducing the number of open jobs rather than through mass layoffs.
The bottom line is that Powell and the Fed now wants to move much more slowly as it sees itself approaching the peak rate level.
That saw Wall Street and European markets fall in a knee jerk reaction, even though investors understand where the Fed is pushing rates. Powell’s comments should not have been a surprise and in fact some commentators thought he was a bit ‘mild’.
It’s all about conditioning the market to believe that policy will remain tight, but ‘accommodative’ for slower pace of rate increases that would help the Fed achieve a soft landing.
It’s all about weakening the economy enough to cut inflation, without causing a deep recession and a surge in jobless numbers next year and into 2025.
The Fed already sees this as a very real prospect, according to two changes to key forecasts last week – GDP growth this year is now expected to be 1%, up from the ultra weak 0.4% forecast in March, while the jobless rate is forecast to now be 4.1% next year instead of the 4.6% forecast in March.
That’s soft landing territory, even if there might be one or two more rate rises in the near term.
But investors broadly expect increases to resume at the Fed’s July meeting and on Wednesday, Fed chair Jay Powell did little to change that view, saying, “Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go,” Powell said on the first of two days of semi-annual testimony on Capitol Hill.
That’s the name of the game for the Fed and Powell then slightly obscured the point by saying the central bank would continue to assess the situation on a meeting by meeting basis, thereby suggesting that rate rises were not going to be pre-ordained for every meeting of the Open Market Committee.
“Nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year,” Powell said Wednesday before the House of Representatives Financial Services Committee.
“We will continue to make our decisions meeting by meeting, based on the totality of incoming data and their implications for the outlook for economic activity and inflation, as well as the balance of risks.”
Asked to clarify the messaging from last week’s Fed meeting, Powell said that keeping rates level was consistent with the Fed’s increasing focus: Slowing the pace of its hikes in order to avoid raising rates higher than needed to reduce inflation and risk causing a deep recession in the process.
“It may make sense to move rates higher but to do so at a more moderate pace,” Powell said, likening the Fed’s rate hikes to a journey. “As you get closer to your destination, as you try to find that destination, you slow down even further.”
It’s clear the Fed has made considerable progress in reducing inflation – more than any other central bank. The inflation has fallen from 9.1% a year ago this month to 4% in May, even though the core reading remains above 5%.
Powell also indicated that the Fed chose to pause last week so it could assess the impact of three bank failures in April and May on the banking sector and whether the failures would reduce credit to consumers and businesses and slow the economy. So far there doesn’t seem to have been much of an impact.
