When Jerome H. Powell spoke at the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole, Wyoming last year, inflation was recently topping 9 percent and the Fed was raising rates at breakneck speed to curb inflation. Mr Powell used the platform to strongly warn that central bankers would hold on until the job was done.
A year later, the picture looks very different. Higher interest rates have cooled the housing market and, combined with recovering supply chains and lower gasoline prices, have brought inflation down significantly – to 3.2 percent in July.
Today, instead of warning that the central bank stands ready to push the economy into recession if it needs to to curb rapid inflation, Fed officials are increasingly suggesting they might be able to pull off what once seemed unlikely: cool down the economy without destroying it.
On his return to the conference later this year, Mr. Powell, who will speak on Friday morning, is expected to continue to stress that the Fed has more work to do to bring inflation back fully to normal. However, many economists and investors believe it may manage to adopt a slightly less aggressive tone than last year.
“I expect Jay Powell to avoid anything that connotes ‘mission accomplished,'” said Jason Furman, an economist at Harvard University – adding that Mr. Powell might suggest there was more work to be done , but need not sound so ominous to Wall Street . “Unlike last year, Powell doesn’t need to scare anyone.”
Mr. Powell’s solemn remarks a year ago — hinting that the Fed would expect economic drag in its bid to cool inflation — was in part a rebuke to investors then skeptical that the Fed would continue to raise interest rates would raise sharply. His comments rattled financial markets as they recalibrated.
But this year, market participants understood that the central bank means business. While they believe the Fed is either done or almost done raising rates, strong economic data has also led them to the possibility that the central bank will leave rates high for longer.
This is particularly evident in the bond market, where the yield on 10-year government bonds rose significantly last month, peaking at over 4.3 percent. The 10-year yield is supporting borrowing across the economy and the impact of this rise is already evident. Mortgage rates this week rose to their highest in more than two decades, while new loan applications fell to their lowest in almost three decades, according to the Mortgage Bankers Association. As it becomes more expensive to borrow to buy a home or expand a business, the sharp change in interest rates over the past year could hurt the economy even as inflation cools.
And while the data has remained mostly good so far – consumer spending and attitudes beat expectations – there is always reason to worry that today’s robust economy could collapse if the Fed’s tightening monetary policy is delayed.
Consumers are slowly running out of savings accumulated during the pandemic, and some companies have warned it could hurt their profits. On Wednesday, new data pointed to an unexpected slowdown in both manufacturing and services last month.
“It was kind of a reality check,” said Bill O’Donnell, rates strategist at Citi Group.
Such risks are a reason for the Fed to be cautious, according to some economists. Officials have already hiked interest rates to their highest level in 22 years — a range of 5.25 to 5.5 percent. While considering another hike before the end of the year, some argue that such a move is unnecessary in an economy with cooling inflation and many policy adjustments already in the pipeline.
However, given the economy’s resilience to date, there is another major threat facing the Fed. Inflation — still very high at 4.7 percent after excluding volatile food and fuel prices — could remain elevated as consumers continue to spend and businesses realize they can continue to charge more.
That’s likely to keep Mr. Powell sounding determined.
Higher government bond yields could actually help mitigate the risk of persistent inflation by reducing demand, analysts said.
“Rates are moving in the direction that the Fed needs them — a few months ago there were concerns that financial conditions would ease, and that has reversed,” said Gennadiy Goldberg, rates strategist at TD Securities. “Growth needs to slow down and that requires tighter financial conditions.”
The rise in market-based interest rates should give officials confidence that their policies are having an impact on the economy and will continue to slow it down, said Michael Feroli, chief US economist at JP Morgan, after commentators spent months wondering why financial conditions were not right reacts more sharply to Fed measures.
“If anything, it removes a mystery or cause for concern,” Mr Feroli said. “I think it will probably be somewhat welcome.”
With some key data yet to be released before the Fed’s Sept. 20 meeting, Mr. Feroli didn’t expect Powell to give too much of a near-term policy signal in Friday’s remarks.
But with rates already at elevated levels and various risks clouding the outlook – including a moratorium on student loan payments expiring and growth in China being disappointingly weak – some saw reasons for that Mr. Powell was more cautious this time in his message to the market.
“That’s exactly what the Fed wants,” Mr. O’Donnell said, citing rising yields and a slowing economy. “Why pour more gasoline on the fire?”
Comments are closed.