The Federal Reserve will likely keep raising interest rates higher than officials had first thought, Chair Jerome Powell told lawmakers in Washington.
In his first of two appearances on Capitol Hill on Tuesday, Powell cautioned the Senate Banking Committee that the latest string of better-than-expected economic data and a modest reversal in the disinflation trend could enable the U.S. central bank to tighten monetary policy faster.
This means one of two things: the benchmark federal funds rate could climb higher than the median rate of 5.1 percent in the December Survey of Economic Projections (SEP), or the Federal Open Market Committee (FOMC) could pull the trigger on rate hikes larger than 25 basis points.
“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell said in his semi-annual Monetary Policy Report address (pdf).
“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
Powell warned lawmakers that the Fed’s inflation-fighting campaign is not over, adding that he and his colleagues understand that these efforts are “causing significant hardship” across the country. But, he noted, the institution is firmly committed to resuscitating price stability and bringing the inflation target rate to the Fed’s 2 percent objective.
“Over the past year, we have taken forceful actions to tighten the stance of monetary policy,” Powell said. “We have covered a lot of ground, and the full effects of our tightening so far are yet to be felt. Even so, we have more work to do.”
The Fed Chair alluded to one specific inflation metric that suggests there is little disinflation: core services excluding housing, which represents more than half of core consumer expenditures.
“To restore price stability, we will need to see lower inflation in this sector, and there will very likely be some softening in labor market conditions,” Powell stated.
On the broader economy, the head of the central bank asserted that “the U.S. economy slowed significantly last year,” as the real GDP (inflation-adjusted) rose at a below-trend rate of 0.9 percent. Recent figures suggest consumer spending is robust this quarter, but “other recent indicators point to subdued growth of spending and production.”
Despite the latest slowdown in the national economy, Powell noted that the labor market is still extremely tight.
“If you could speak directly to the two million hardworking people who have decent jobs today who you’re planning to get fired over the next year, what would you say to them?” Sen. Elizabeth Warren (D-Mass.) asked.
But Powell rejected this premise, conceding that the Fed no longer believes the labor market needs to endure an immense jump in unemployment to rein in inflation.
Still, according to the semi-annual report, combating inflation will require “softer labor market conditions,” including fewer job openings and more layoffs.
In December, the Bureau of Labor Statistics reported that there were more than 11 million job openings. In January, there were nearly 103,000 job cuts, according to data from Challenger, Gray and Christmas.
However, Sen. Jon Kennedy (R-La.) cited a study by The Economist that examined 10 disinflationary periods and concluded that in order to trim inflation by 2 percent, the unemployment rate had to rise by 3.6 percent.
“Now, that’s history, is it not?” the senator noted.
“But if history is right, unless you get some help, in order to get inflation down from 6.4 percent to, let’s say, 4.4 percent and the unemployment rates got to rise to 7 percent based on history, that’s what the record would say. Okay, and to get inflation down to 2.2 percent, based on the history and immutable facts, unemployment would have to go to 10.6 percent.”
In the end, Powell acknowledged that the Fed’s actions “affect communities, families, and businesses” nationwide.
“We understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission,” Powell told the hearing. “We at the Federal Reserve will do everything we can to achieve our maximum-employment and price-stability goals.”
During and after the Senate Banking Committee hearing, the financial markets suffered an intense selloff, with the leading benchmark indexes down at least 1 percent. In addition, cryptocurrency, energy, and metal markets tanked.
But the U.S. Dollar Index (DXY), which gauges the buck against a basket of currencies, rallied more than 1 percent to above 105.00.
The U.S. Treasury market was mixed on Tuesday, with the benchmark 10-year yield down by nearly 2 basis points to below 3.97 percent.
But while investors digest Powell’s testimony, some economists paid attention to what senators were also espousing.
William Luther, the director of the American Institute for Economic Research’s (AIER) Sound Money Project, was surprised by Democrats maintaining “a broken narrative on inflation.” Senate Banking Committee Chair Sherrod Brown (D-Ohio) and some of his colleagues referenced Russia’s invasion of Ukraine, the avian flu outbreak, corporate greed, and the supply chain crisis as reasons for rampant price inflation.
“This view is inconsistent with the available data,” Luther, an Associate Professor of Economics at Florida Atlantic University, told The Epoch Times following the hearing. “The inflation we’re experiencing today is not primarily driven by supply-side factors. They’re driven by a surge in nominal spending that was caused by government spending that was financed with more borrowing and a chunk of which was accommodated by the Federal Reserve.”
Although Kennedy accepted that Powell did not want to intervene in a policy dispute in Washington, he told the Fed Chair that Congress needed to reduce the rate of growth of spending and debt accumulation.
“But the more we help on the fiscal side, the fewer people you’re gonna have to put out of work,” Kennedy said.
Meanwhile, according to David Rosenberg, the founder and president of Rosenberg Research Associates, nothing Powell told lawmakers was new.
“Equities are reversing course today but, come on. Show me one thing in Powell’s testimony that we didn’t already know. Him saying nothing new is more impactful for Mr. Market than five successive quarters of negative EPS growth?” he wrote on Twitter.
Powell is scheduled to appear before the House Financial Services Committee on Wednesday.