WASHINGTON – Federal Reserve Chairman Jerome Powell confirmed on Wednesday that a small interest rate hike is likely, even as he sees progress in the fight against inflation as largely insufficient.
Echoing recent statements from other central bank officials and comments at the November Fed meeting, Powell said he sees the central bank in a position to reduce the size of rate hikes as soon as next month.
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But he cautioned that monetary policy is likely to remain accommodative for some time until real signs of progress on inflation emerge.
“Despite some promising developments, we have a long way to go to restore price stability,” Powell said in remarks delivered at the Brookings Institution.
The chairman noted that policy moves such as interest rate hikes and reductions in the Fed’s bond holdings typically take time to work their way through the system.
“Thus, it makes sense to reduce the pace of our rate hikes as we approach a level of moderation that will be sufficient to bring down inflation,” he added. “The time may come to reduce the pace of rate hikes at the December meeting.”
Wall Street applauded the comment. The Dow Jones Industrial Average closed up 737 points, or 2.18%, snapping a three-season losing streak. Tech stocks fared even better, with the Nasdaq Composite gaining 4.41%.
“The day-to-day rally in equity markets is a relief rally,” wrote Krishna Guha, head of global policy and central bank strategy at Evercore ISI. “Many investors had feared that the Fed chair would recently act as a maximally aggressive sledgehammer to ease financial conditions … That impasse is now gone.
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According to data from CME Group, the market was already pricing in a roughly 65% chance that the Fed would raise its interest rate by half a percentage point in December, after four consecutive 0.75 basis points moves. The pace of rate hikes is the most aggressive since the early 1980s.
After Powell’s speech, the probability of a half-point move increased to 77%.
It remains to be seen where the Fed goes from there.
Markets took a more lenient tone from Powell’s speech, with the top rate set at just 5% until May 2023 and the condition that the Fed would cut by a half point by the end of the year.
Pricing in the possibility of a rate cut countered Powell’s warning that restrictive policy would remain in place until inflation shows more consistent signs of abatement.
“Given our progress in tightening policy, the timing of that moderation is much less important than the question of how much further we will need to raise rates to control inflation, and stay at restrictive levels for a period of time.” It will be necessary to maintain the policy.”, Powell said.
“It is likely that policy will need to be maintained at restrictive levels for some time to restore price stability. History strongly warns against prematurely easing policy,” he added. “We will stay the course until the work is done.”
Powell’s comments came alongside some rumbling signs that inflation is easing and the ultra-tight labor market is loosening.
Earlier this month, the consumer price index showed inflation rising but below what economists had expected. Separate reports on Wednesday showed private payrolls growth was much lower than expected in November while job openings also declined.
However, Powell said short-term data can be misleading and he needs to see more consistent evidence.
For example, he said Fed economists expect the central bank’s favorite personal consumption expenditure price index to be released in October to show inflation at a 5% annual pace in October. That would be lower than the 5.1% in September but still well ahead of the Fed’s 2% long-term target.
Powell said, “It will take much more evidence to give comfort that inflation is indeed declining.” “By any standard, inflation remains very high.”
“All I would say is that we have more ground to cover,” he said.
Powell said he expects the final peak for rates – the “terminal rate” – to be “a little higher than thought” when members of the rate-setting Federal Open Market Committee made their last estimates in September. Committee members said at the time that they expected the terminal rate to reach 4.6%; Markets now see it in the 5%-5.25% range, according to data from CME Group.
Powell said supply chain issues lay low at the core of the inflation burst, while growth has largely slowed to the downside, even with a 2.9% annual gain in third-quarter GDP. He expects housing inflation to pick up next year but is likely to decline again.
However, he added that the labor market showed “only tentative signs of rebalancing” after job openings outnumbered available workers by a 2-to-1 margin. The gap has closed to 1.7 to 1 but remains well above historical norms.
The tight labor market has resulted in huge increases in workers’ wages that have yet failed to keep up with inflation.
“To be clear, strong wage growth is a good thing. But for wage growth to be sustainable, it needs to be in line with 2% inflation,” he said.
Powell spoke at length about the factors keeping labor force participation low, a key factor in addressing the imbalance between open jobs and available workers. He said that “additional retirement” is an important issue during the Covid pandemic.