In more ways than one, the Fed’s Powell showed his strategy this week

U.S. Federal Reserve Chairman Jerome Powell testifies during the Senate Banking Committee hearing on ‘The Semi-Annual Report on Monetary Policy to Congress’, in Washington, U.S., March 3, 2022. Tom Williams/ Pool via REUTERS

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WASHINGTON, May 6 (Reuters) – With a war in Europe ongoing, a pandemic still shutting down swathes of the global economy and financial markets have become highly volatile, the U.S. economic outlook remains unpredictable.

But Federal Reserve Chairman Jerome Powell this week presented his most detailed account of the strategy for dealing with a generational inflationary shock while avoiding any significant increase in unemployment.

There are a lot of things that could go wrong, either in the direction of an even bigger inflation problem or an economy starting to collapse unexpectedly.

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The Fed Powell is trying to cover both possibilities.

Here’s how:


Powell, with little ambiguity, told a press conference on Wednesday that while the Fed would not hesitate to raise interest rates as high as necessary to rein in inflation, policymakers were not ready. to deliver a shock treatment, such as a three-quarter point rate hike.

His comments came after the Fed announced it would raise its benchmark overnight interest rate by half a percentage point and begin shrinking its balance sheet next month. Read more

Some analysts felt that Powell was unwittingly “dovish” in doing so, and investors, after some hesitation, remain convinced that the Fed will have to act more quickly.

But there is another possibility.

“I don’t think that’s a slip,” said former Fed monetary policy chief Bill English, now a professor at the Yale School of Management. “They don’t want to be a source of uncertainty, so come on steadily. Seventy-five (basis points) might have shaken things up.”

Powell was unusually explicit in signaling the likelihood of half-point rate hikes at the next two Fed meetings.

Fed forward guidance is more traditionally done with modifiers like “incremental” which investors translate into an expected pace of rate hikes.

Powell seems rather ready to simply say what is likely to happen. His Wednesday press conference was the third recent instance where he actually identified the outcome of the future meeting. While decisions aren’t final until policymakers vote, Powell may be reaffirming his voice as president at a time when he wants the message to be kept clear and simple and not muddied by public debate among his colleagues. .

“It’s sort of old-school monetary policy,” said former senior Fed official Vincent Reinhart, chief economist at Dreyfus and Mellon. What Powell is saying is, “In an environment of uncertainty, we don’t know where we’re going to end up. We know which way we need to go, and the more we do, the closer we’ll be to the future. where we should be and I’ll let you know then.”

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Fed officials said they would “rapidly” raise the federal funds rate to “neutral,” a level that, in theory, will not encourage households and businesses to borrow and spend, but will discourage them. neither.

But it’s a squishy concept and can vary over time.

Powell clarified on Wednesday that the goal is to achieve “the broad range of plausible levels of neutrality,” which officials estimate at 2% to 3% for the target federal funds rate.

By switching to rate hikes of half a point instead of a quarter point, the fed funds rate will now be at the lower end of this range in July, an attractive fact for officials who want the monetary policy either “preloaded” or tightened more quickly. It also leaves room for the Fed to assess the behavior of inflation and the economy over the next couple of months, then alter the pace of rate hikes if necessary – an attractive fact for those worried about triggering. a recession.

As an economic concept, the trend toward neutrality—as broad as Powell defined it—keeps policymakers from all walks of life on the same page without committing them to a rising rate pace or end destination. .

Among the many unusual aspects of the reopening of the economy after the pandemic is the high number of job vacancies compared to the number of people looking for work, with almost two vacancies for all the unemployed.

Measured differently, Goldman Sachs economists note that the total number of jobs plus openings is about 5.6 million more than the total labor force, a huge discrepancy that suggests something is wrong. It has been difficult for companies to hire and may have started to make inflation worse by raising wages.

The Fed’s hope is that the math doesn’t go through an actual rise in unemployment – a common outcome when monetary policy tightens rapidly – but by prompting companies to scale back hiring plans as demand declines. under the influence of higher interest rates.

Powell Wednesday wouldn’t say what he’s aiming for. But in the years before the pandemic, when the vacancy-to-unemployment ratio was 1.2 to 1, jobs and wages were growing at a sustained pace and inflation was close to the 2% target for the Fed.

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Powell, as much as at any time during the pandemic, has tried to make uncertainty a virtue and recognize what the Fed doesn’t know and what it can’t control. On Wednesday, he noted some signs that inflation may be peaking, but also that “more surprises may be in store.” He said the inflationary psychology was not taking root, but opened his press conference with an appeal to the “American public” about their commitment to slowing prices, as if to help control that psychology.

The subtext: Be ready for anything.

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Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci

Our standards: The Thomson Reuters Trust Principles.

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