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  • by Smriti Mathur
  • Dec 01, 2022
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Fed Chair Powell Says Smaller Interest Rate Hikes Could Start In December

 

 

Key Points: 

  • Fed Chairman Jerome Powell reiterated on Wednesday that modest interest rate rises are inevitable and that they might begin in December.
  • However, he stressed that monetary policy will likely remain restrictive for some time unless actual evidence of progress on inflation materialises.
  • "We will maintain the course until the job is done," he declared at the Brookings Institution in Washington, D.C.I was.

 

Federal Reserve Chairman Jerome Powell reiterated Wednesday that smaller interest rate rises are inevitable, despite his assessment that progress fighting inflation has been largely insufficient.

Powell, echoing previous pronouncements from other central bank officials and comments made during the November Fed meeting, stated that the central bank is in position to cut the magnitude of rate hikes as soon as next month.

 

However, he stressed that monetary policy will likely remain restrictive for some time unless actual evidence of progress on inflation materialise. 

"Despite these encouraging signs, we still have a long way to go in restoring price stability," Powell remarked at the Brookings Institution.

The chairman underlined that policy decision like raising interest rates and reducing the Fed's bond holdings take time to work their way through the economy.

The chairman underlined that policy decision like raising interest rates and reducing the Fed's bond holdings take time to work their way through the economy.

"As we approach the level of restraint that will be necessary to drive inflation down," he continued, "it seems sense to decrease the pace of our rate rises." "The time for slowing the pace of rate rises could arrive as early as the December meeting."

 

The words were met with applause on Wall Street. The Dow Jones Industrial Average ended the day up 737 points, or 2.18%, snapping a three-session losing trend. Tech companies performed even better, with the Nasdaq Composite gaining 4.41%.

"The on-the-day equities market jump is in part a relief rally," wrote Krishna Guha, Evercore ISI's head of global policy and central bank strategy. "Many investors feared that the Fed chair would slam the recent easing of financial conditions with a hawkish sledgehammer... That overhang is no longer there."

As per CME Group data, markets had already priced in approximately a 65% possibility that the Fed would reduce its interest rate rises to half a percentage point in December, after four consecutive 0.75-point increases. This rate hike pace is the most aggressive since the early 1980s.

 

Following Powell's remarks, the likelihood of a half-point move increased to 77%.

What remains to be seen is the Fed's next move.

Following Powell's speech, markets took a more dovish tone, with the top rate set to be just shy of 5% by May 2023 and bets that the Fed will slash half a point by the end of the year.

The pricing in of rate cuts contradicts Powell's caution that restrictive policy will remain in place until inflation shows more consistent signs of easing.

"Given our work in tightening policy, the timing of that moderation is substantially less crucial than the considerations of how far we will need to raise rates to manage inflation, and how long we will need to retain policy at a restrictive level," Powell said.

"It is likely that restoring price stability will necessitate a period of policy restraint. History warns against prematurely easing policy "He continued. "We shall persevere till the project is completed."

Powell's comments coincide with some encouraging signals that inflation is easing and the ultra-tight labour market is loosening.

Earlier this month, the consumer price index showed that inflation was rising, but by less than economists had predicted. Separate statistics released on Wednesday showed that private payroll growth was significantly lower than projected in November, while job vacancies were also down.

 

Powell, on the other hand, believes that short-term data can be misleading and that he needs to see more consistent evidence.

For example, he stated that Fed experts anticipate the October publication of the central bank's preferred core personal consumption expenditures price index, which will show inflation running at a 5% annual rate. This would be a decrease from 5.1% in September, but still substantially above the Fed's long-run target of 2%.

"Significantly more data is required to provide comfort that inflation is indeed reducing," Powell said. "By any measure, inflation is still far too high."

"I'll just say we have more ground to cover," he continued.

Powell also stated that he believes the ultimate rate peak - the "terminal rate" - will be "slightly higher than envisaged" when the Federal Open Market Committee members issued their most recent predictions in September. Committee members predicted a terminal rate of 4.6% at the time; markets currently expect it to be in the 5%-5.25% range, according to CME Group statistics. 

The supply chain concerns at the heart of the inflation surge have subsided, according to Powell, while overall growth has slowed to below trend, despite a 2.9% annualised gain in third-quarter GDP. He expects home inflation to climb this year but then decline.

However, he said that the labour market has exhibited "only tentative signs of rebalancing" after job openings outweighed available employees by a two-to-one ratio. This disparity has narrowed to 1.7 to one, although it remains significantly higher than historical standards.

The tight labour market has resulted in significant increases in worker earnings, but they have failed to keep pace with inflation.

"To be fair, rapid wage increase is desirable. However, in order for wage growth to be sustainable, it must be consistent with 2% inflation "He stated.

Powell went into detail on the causes that keep labour force participation low, which is a critical factor in correcting the mismatch between open jobs and available employees. During the Covid epidemic, he added, "excess retirements" were a major issue.

 

The Fed makes history with a fourth straight three-quarter-point rate hike

On Wednesday, the Federal Reserve approved a fourth-straight rate hike of three-quarters of a percentage point as part of its vigorous effort to bring down the US economy's white-hot inflation.

With the massive increase, the central bank's benchmark lending rate now has a new target range of 3.75% to 4%. The fed funds rate has already reached its highest level since January 2008.

The Fed's decision on Wednesday, which comes at the end of a two-day policy meeting of the Federal Open Market Committee, represents the Fed's toughest policy move since the 1980s and is likely to exacerbate economic pain for millions of American businesses and households by raising borrowing costs even higher.

 

There's also a danger it'll spark a recession. 

Following the meeting, Fed Chairman Jerome Powell admitted that the route to a soft landing – slowing the economy without entering a recession — had narrowed, but that it was still conceivable.

 

"Over the course of this year, the inflation situation has become increasingly problematic," he said. "That implies we have to tighten policy, which narrows the route to a soft landing."

He also reaffirmed his commitment to lowering inflation and his belief that protracted, entrenched inflation causes more economic harm than a recession.

The Fed included a new section in its November statement, which is unusual given that the Fed normally repeats the same language in each release. The Fed's policymaking arm, the Federal Open Market Committee, "anticipates that continued increases in the target range will be appropriate in order to achieve a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time."

Fed watchers may take the inclusion of "over time" to the Fed's inflation rate target as dovish, implying that the Fed may opt to shift away from aggressive rate hikes and toward modest, longer-term increases.

Furthermore, the statement stated that "the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments" in determining the pace of future increases in the target range.

This new terminology may also pave the path for a future interest rate cut, as it acknowledges that monetary policy is already effectively cooling the economy, even while economic data, which typically lags, shows strong growth.

Wall Street may also interpret the wording as a reaction to recent criticism that the Fed is overcorrecting with aggressively high interest rate hikes that are harming the economy unnecessarily.

Recent data emphasises the "choose your own adventure" nature of the US economy: mortgage rates at levels not seen in nearly 20 years are beginning to suffocate the housing market. Sales of newly constructed homes fell 10.9% in September compared to August and 17.6% year on year.

Nonetheless, some inflationary pressures are subsiding. According to the Employment Cost Index, wages and salaries increased by 1.2% in the third quarter, down from 1.6% in the second.

Nonetheless, some inflationary pressures are subsiding. According to the Employment Cost Index, wages and salaries increased by 1.2% in the third quarter, down from 1.6% in the second.

And the job market has remained tight throughout. In September, job opportunities surprisingly increased, indicating that there are 1.9 job openings for every available worker. The next employment report on Friday is likely to reveal that the economy added another 200,000 jobs in October, a decrease from the previous month but still a historically high number.

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