Federal Reserve Chairman Jerome Powell speaks to reporters after the Fed raised its target interest rate by a quarter percentage point, during a news conference at the Federal Reserve Building in Washington, U.S., February 1, 2023. REUTERS/Jonathan Ernst
2. February (Reuters) - Federal Reserve Chairman Jerome Powell had a clear message on Wednesday that as "encouraging" as it's that inflation is starting to slow, the central bank is far from changing course or declaring victory.
"It'll take some time" for disinflation to spread through the economy, Powell said in a news conference after the latest quarter-point rate hike. He said he expects a few more rate hikes, and "given our outlook, I just don't see us cutting rates this year."
Investors ignored him and continued to bet on just one more rate hike and continued to bet that rates will be lower by the end of the year than they're now.
It's not clear which view will prove correct: Neither the Fed nor the markets have a good forecasting record since the current round of central bank rate hikes began last March.
Markets have repeatedly had to abandon bets on a quick turnaround in interest rates, pushing expectations further out as the central bank pushed ahead with the most aggressive tightening of monetary policy in 40 years.
Fed policymakers have revised up their own rate estimates every quarter for the past year as inflation proved stronger and more stubborn than expected. Not once did they signal that rates would be lowered this year.
How the current discrepancy resolves will depend largely on whether inflation falls faster than the central bank expects, or whether labor markets soften further than it hopes.
The authentic effect relies upon on the data, and we won't have the facts to verify or deny it till we get deeper into the first 1/2 of the year, said Tim Duy, chief U.S. economist at SGH Macro Advisors.
And as long as that uncertainty remains, it's in Powell's interest to keep financial markets from betting too much on rate cuts that would loosen financial conditions and potentially undermine the Fed's hard-won progress in fighting inflation.
Even simply acknowledging the possibility of a rate cut later this year could undo some of the Fed's work, force further Fed tightening, and make avoiding a recession even more difficult. Hence Powell's repeated assurances that rates won't be cut, but that they must remain at least above 5%, as policymakers projected in December.
"Our view is that we aren't yet pursuing sufficiently restrictive policy, so we believe that further rate increases are appropriate," Powell said.
But so far, said Megan Greene, global chief economist at the Kroll Institute, "markets aren't buying what the Fed is touting"
The central bank's benchmark overnight rate currently stands at 4.50-4.75%. Interest rate futures traders expect another 25 basis point hike in March before the Fed pauses to assess the extent to which its near-zero rate increase a year ago is slowing the economy.
They expect rate cuts to begin in September - a view Powell said Wednesday is motivated by expectations of rapidly declining inflation.
A September rate cut or a wait until next year would be within historical bounds. Since the 1990s, the interval between rate hikes and cuts has ranged from 18 months (1997-1998) to five months (1995).
Inflation data have moved in the right direction over the past three months. By the Fed's preferred measure, inflation is currently running at an annual rate of 5.0%, still more than double the central bank's target of 2%, but below last summer's peak of 7%.
Wage pressures are also easing, which could allow the Fed to cut rates later this year as it tries to achieve a "soft landing" in which inflation declines without seriously harming economic growth and employment.
DON'T WANT TO REV THE ECONOMY
The Fed is also wary of fighting inflation too hard and cutting rates too soon. Powell and others point to the last major inflation war waged by the Fed in the last 1970s and early 1980s as a cautionary tale.
"Investors are asking him to be Arthur Burns, and he won't accept that invitation," Vincent Reinhart, chief economist at Dreyfus and Mellon, said of Powell.
Under Fed Chairman Burns, the Federal Reserve had repeatedly raised and then lowered interest rates in the 1970s to combat rising unemployment until prices exploded again, forcing more rate hikes. His successor, Paul Volcker, eventually raised rates to nearly 20% to finally combat the inflation that Burns had allowed to get out of hand.
The Fed, Powell said Wednesday, can't risk doing too little. "We have neither an incentive nor a desire to do too much, but if we feel we have gone too far ... if inflation is falling faster than we expect, then we have tools that we can use to respond," he said.
Then there is the thorny issue of financial conditions, an indicator of how easy it is to access credit, which the Fed is watching closely to determine how tight the cost of credit really is.
Financial conditions began to loosen after the central bank's meeting last November, and while Powell largely addressed those concerns Wednesday, the Fed can not afford for them to loosen further
"This easing of financial prerequisites is definitely now not what the Fed was aiming for, and we count on a cacophony of speeches from the Fed in the coming weeks aimed at realigning the Fed's message," said Gregory Daco, chief economist at EY Parthenon.