Powell keeps options open, promises nothing


US Federal Reserve

At yesterday’s meeting, the Federal Reserve (Fed) raised policy rates by 25 basis points, taking the benchmark rate up to 5.25%-5.5%, the highest level since 2001.

While the market had fully anticipated the decision to raise policy rates, Chair Powell gave nothing away regarding future decisions. He repeatedly reiterated the data dependency of the Fed’s next few meetings, simply noting that the FOMC is prepared to tighten policy further, if appropriate.

Receding inflation, strong economic data

In recent weeks, the market has celebrated a drop in headline inflation to 3% and continued evidence of a resilient labor market. While Powell acknowledged the downside inflation surprise, he slightly downplayed its importance, noting that it is just one month’s data and that markets should not read too much into it. He also pointed out that the process of getting inflation down to 2% has a long way to go, potentially taking until 2025, which signals that policy will likely need to remain restrictive for some time.

In addition, while Powell welcomed that the unemployment rate is unchanged from when the Fed started to raise rates last year, he also pointed out that they are looking for the labor demand/supply dynamics to come back into better balance. Historically, labor market conditions have tended to soften when monetary policy is tightened, and, as Powell pointed out, a weakening labor market remains the most likely outcome from here.

Future policy shrouded in mystery

While the market was very confident that the Fed would raise policy rates today, future policy decisions are considerably less certain. In fact, Chair Powell did not provide any hints at all! He pointed out that there are two jobs reports, two inflation reports, and a multitude of other economic data releases before the next FOMC meeting in September.

When questioned, Powell also pushed back at the idea that the Fed has potentially shifted to a pace of rate hikes at every other meeting. Instead, he repeated that the committee could either keep rates steady in September or raise rates at that meeting – truly insightful guidance!

Our own long-held forecast is for rates to peak at 5.25%-5.5% – their current level. Yet, given the confusing signals of waning inflation but a strong economy, keeping all options on the table seems sensible. Indeed, with commodity prices on the rise again and the labor market showing minimal signs of slowing, we can’t entirely rule out the possibility of an inflation resurgence lurking around the corner.

Soft landing hopes

Powell started 2023 as a lonely figure, believing a soft landing for the U.S. economy was possible. In the past month, however, many Wall Street analysts have capitulated to his view and, as Powell revealed today, Fed staff forecasts have also shifted from recession to soft landing. In our view, and despite those shifts, the “long and variable” lags of monetary policy must surely mean that recession risk is still alive and elevated.

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