Federal Reserve Chairman Jerome Powell is preparing to come before Congress with a difficult task: persuade lawmakers that he is committed to lowering inflation while not harming the rest of the economy.
Markets have been on pins and needles, waiting to see if he can pull it off. The mood has been more upbeat in recent days, but that might change quickly if the central bank chief stumbles this week during his semiannual testimony on monetary policy.
“He needs to thread the needle here with two messages,” said Silvercrest Asset Management’s head of investment policy and strategy, Robert Teeter. “One of them is repeating some of his previous comments that there has been some movement on inflation.”
“The second element is being fairly persistent in terms of the prospect for rates continuing high. “He’ll probably emphasize that rates will remain high for some time until inflation is decisively solved,” Teeter added.
If he takes that posture, he will almost certainly face criticism from the Senate Banking Committee on Tuesday, followed by the House Financial Services Committee on Wednesday.
Democratic legislators, in particular, have expressed concern that the Powell Fed’s commitment to combat inflation risks dragging down the economy, particularly those at the lowest end of the wealth spectrum.
Starting slowly out of the blocks
Over the past year, the Fed has raised its benchmark interest rate eight times, most recently by a quarter percentage point hike early last month, bringing the overnight borrowing rate to a target range of 4.5%-4.75%.
Investors have also been caught between wanting the Fed to reduce inflation and being concerned that it may go too far. The central bank’s tardy start in addressing growing living costs has fueled fears that it may be unable to reduce prices without creating at least a minor recession.
“Inflation is a serious issue. That was exacerbated by the Fed’s failure to recognize it until 2021,” said Komal Sri-Kumar, head of Sri-Kumar Global Strategies.
Sri-Kumar believes the Fed could have intervened sooner and more strongly, such as with a 1.25 percentage point rise in September 2022, when consumer price inflation was 8.2% year on year. Instead, the Fed began lowering the number of its rate hikes in December.
Now, he claims, the Fed will have to raise its fund’s rate to roughly 6% before inflation subsides, causing economic harm.
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“I don’t believe in this no-landing scenario,” Sri-Kumar added, alluding to the belief that the economy will experience neither a “hard landing,” nor a harsh recession, nor a “soft landing,” or a lesser downturn.
“Sure, the economy is doing well. But that doesn’t imply you’ll get by with no recession,” he said. “If you’re going to have a no-landing scenario, then you’re going to accept 5% inflation, and that’s politically unpalatable. He needs to work on lowering inflation, which will be delayed because the economy is so strong. Yet the more you wait, the deeper the recession will be.”
‘Continual increases’ are on the way.
Powell, for his part, will have to strike a balance between conflicting policy perspectives.
The Fed’s monetary policy report to Congress, released on Friday as a prelude to Powell’s testimony, repeated oft-quoted phrasing indicating officials expect “ongoing hikes” in rates.
The chairman will most likely “adopt a tone that is both determined and measured,” according to Krishna Guha, head of global policy and central bank strategy at Evercore ISI, in a client note. Powell will praise the “resilience of the actual economy,” but warned that inflation data has risen and that the road to managing it “will be lengthy and rough.”
Guha, on the other hand, believes Powell is unlikely to raise interest rates by a half-point, or 50 basis points, later this month, as some investors anticipate. According to CME Group statistics, market pricing on Monday indicated a 31% possibility for the larger move.
“We believe the Fed will raise rates by 50 basis points in March only if inflation expectations, wages, and services inflation reaccelerate dangerously higher and/or incoming data is so strong that the median peak rate ends up rising by 50 basis points,” Guha wrote. “The Fed cannot end a meeting more away from its goal than it was before the meeting began.”
Yet, interpreting the data will be difficult in the future.
Headline inflation may actually fall precipitously in March, as year-over-year comparisons of energy costs may be distorted due to a price spike at this time last year. According to the Cleveland Fed’s tracker, all-item inflation fell from 6.2% in February to 5.4% in March. Core inflation, which excludes food and energy, is expected to rise to 5.7% from 5.5%.
Guha believes Powell might push the Fed’s endpoint for rate hikes — the “terminal” rate — up to a 5.25%-5.5% range, or about a quarter point higher than officials predicted in December’s economic estimates.