Jay Powell assured financial markets and the American public a little more than two weeks ago that the Federal Reserve would be “humble and nimble” as it trained its sights on fighting inflation.
But the chair of the US central bank is already facing doubts about whether he is adapting quickly enough and communicating effectively regarding the Fed’s response to stubbornly elevated prices.
After another higher-than-expected consumer price index reading last Thursday, investors started betting on an earlier and more aggressive run of interest rate increases than signalled by the Fed so far.
Some traders and economists even started speculating that the central bank might be forced to act on an emergency basis to introduce the first interest rate rise before its next scheduled meeting in mid-March.
The Fed is highly unlikely to take such a step, which is reserved for urgent course corrections in extreme circumstances, but even the discussion of it among some followers of the central bank and market participants has highlighted the pressure on Powell.
“I think Powell has to regain the reins of monetary policy and clarify what his position is in terms of tightening,” said Gregory Daco, chief economist at EY-Parthenon.
Ellen Zentner, chief US economist at Morgan Stanley, wrote in a note to clients on Friday: “The Fed’s job has gotten harder, not easier, as it approaches lift-off.”
At the end of the last Federal Open Market Committee meeting in January, Powell stressed that the central bank would rely on incoming data to judge how forcefully it would move to raise rates.
He has already shifted to a more hawkish position: whereas in the tightening cycle that followed the financial crisis the Fed moved very gradually to raise rates, Powell has made clear that he is open to moving faster if necessary. This could potentially mean interest rate increases of 50 basis points rather than 25bp in the first part of this year.
But while some particularly hawkish members of the FOMC such as James Bullard, president of the Saint Louis Fed, are inclined to go bigger and earlier, there is not a clear consensus across the Fed to set policy along those lines.
Mary Daly, president of the San Francisco Fed, struck a more cautious note in an interview with CBS on Sunday. “The most important thing is to be measured in our pace and, importantly, data-dependent,” Daly said.
The most recent data — including the latest CPI report and a strong jobs report, which showed the labour market recovery withstanding the hit from the Omicron coronavirus variant — have bolstered the case for more aggressive tightening, but probably only on the margins.
Between now and the two-day meeting starting on March 15, the economic picture, and the potential case for steeper tightening, might become more apparent with the release of one additional monthly jobs report and an additional CPI reading. Meanwhile, on the international front, Fed officials will be weighing the effect of a possible armed conflict in Ukraine, if Russia decides to launch an invasion of its neighbour.
At the heart of Powell’s calculations, and those of the rest of Fed officials, will be the best route to stamp out inflation in a way that does not jeopardise the recovery. To some economists and Fed-watchers, Powell and the central bank are still playing catch-up on inflation and need to cool the economy rapidly in order to prevent more dramatic interventions in the future.
“Once inflation becomes entrenched at a high level, it is difficult if not impossible to bring [it] back to target without pushing rates above neutral and setting the stage for a recession,” said Tim Duy, chief US economist at SGH Macro Advisors and a professor at the University of Oregon.
But other economists warn that if the Fed steps in with too much tightening early on, it risks inflicting unnecessary damage to the economy, particularly because fiscal support has faded and forecasters are generally expecting inflation to ease over the course of the year.
“It’s extremely hard to slow an economy without excessively slamming the brakes, and doing too much — and risking a slowdown that was not initially desired,” said Daco at EY-Parthenon.
One of the biggest sources of policy uncertainty and market volatility around the Fed’s intentions is that Powell and the central bank’s top brass have not spoken publicly since the press conference after the last FOMC meeting.
Nor are there any plans to do so early this week: the most weighty comments may come from John Williams, president of the New York Fed, but he is not due to speak until Friday.
Powell himself is still awaiting Senate confirmation for his second term as chair, and is technically leading the Fed on a “pro tempore” basis. He is likely to testify before Congress at some point in the coming weeks, but nothing is on the calendar.
For now, Powell’s decision to keep investors guessing about how he views the Fed’s tightening route has seemed to have left both sides of the inflation debate unhappy. Economists championing a robust intervention say he is still too vague and hesitant about his commitment to curtailing price rises — while those worried that the Fed might overreact say the silence from top officials implies consent for the market pricing of aggressive action.
But for Powell and many Fed officials, keeping their options open seems like the preferred stance.
“I see risks on both sides. If we act too aggressively, then we could actually add to American’s uncertainty,” said Daly. “If we act too slowly, we have accommodation that is too much for the economy.”