What we read in Chairman Powell’s Fed Testimony

In his testimony delivered on Tuesday, Powell almost reiterated most of the things that he has said over the last couple of months since the undertone of the data had changed. Here are some major takeaways from Jerome Powell’s Fed testimony.

Price stability will not be compromised

That is something that Powell has been increasingly focusing on over the last couple of months, since the Fed turned slightly hawkish. As Powell reiterated, the Fed remained steadfastly committed to its 2% inflation goal in the medium to long run. Powell also added that the full impact of the tightening was yet to show up and that may involve a lag. However, the statement from Powell was fairly clear on the intent of the Fed going ahead. “While our policy actions are guided by the dual mandate of maximum employment and stable prices; without price stability, the economy does not work for anyone.” That best sums up where the focus of the Fed and the Fed chair will be in the coming months.

Clear reversal in the softening trend

This has been the theme of the Fed, when it announced the minutes of the February FOMC meet. That has one again been reiterated by Powell in his testimony to the Senate Banking Committee. The data for January on employment, consumer spending, manufacturing and inflation had partly reversed the softening trends had had been visible in November and December 2022. While part of the reversal in data in January can be attributed to the warm weather, Powell underlined that the breadth of the reversal combined with revisions to the previous quarter were indicative of rampant inflationary pressures in the US economy. As Powell has underlined time and again, the January data flows were a shocker and showed that it was still too early to call the end of rate hikes or even being close to the end.

Hardly any sign of disinflation, says Powell

In a sense, disinflation is the opposite of inflation. When prices start coming off, as can be expected from aggressively hawkish monetary policy, that is disinflation and it shows that the inflation momentum is shifting. As Powell put it, despite the tapering of inflation, disinflation was hardly visible in the January data. For instance, despite moderating, inflation has remained well above the FOMC target of 2% since the middle of 2022. The PCE inflation, which the Fed uses for monetary policy decisions, had slowed from its peak of 7.0% in June 2022 to 5.4% in January 2022. However, as Powell put it, this fall is more due to weakening of energy prices, even as food and core inflation continue to remain sticky and persistent. That is not a very good example of sustained disinflation, which is worrying.

GDP Growth is still a question mark

In his testimony, Powell has expressed some strong reservations about the traction in real GDP growth. In the year 2022, the US economy slowed significantly with real GDP growing at well below 0.9%. The irony is that expanding consumer spending is normally consistent with high GDP growth, in an economy like the US which is largely consumption driven. However, other than consumer spending, other drivers of growth have not been supportive. For example, activity in the housing sector continues to weaken, largely reflecting higher mortgage rates. Apart from the impact on individual housing, the higher interest rates and slower output growth are also starting to weigh on business fixed investment. Overall, there is pressure on any kind of investment outlays in the economy, which is not accretive for the economy in the longer term.

Jobs are the real joker in the pack

There is a strange irony in the US markets as Powell puts it in the testimony. Despite the slowdown in growth, the labour market or the jobs market remains extremely tight. That means the demand is far in excess of supply, which is putting upward pressure on wages. Look at the numbers. The unemployment rate was 3.4% in January 2023, a level that was last seen in the year 1969. Job creation has been much stronger than expected but the availability of labour has been a big drag. For instance, on an average, in the US jobs market, there are 1.9 job openings for each unemployed individual. It is not just that this ratio is at a historically high level, but even the unemployment insurance claims have remained near historical lows. This is a combination of events that is putting pressure in the ability of higher rates to translate into lower inflation as strong purchasing power is the barrier.

So, here is what the Fed proposes to do

What does this Fed testimony say about the future trajectory of Fed action? That is the million dollar question. The Fed stance is quite clear from the Fed testimony of Jerome Powell on 07th March 2023. In terms of policy outcomes, here are the implications.

1. With inflation well above the long run goal of the Fed at 2% and tight labour market, the FOMC is likely to continue to hike rates well above the current range of 4.50%-4.75%. This also virtually does away with any chances of rate cuts in 2023 and that may now be put off to 2024. The terminal rates are not yet evident at this point, but going by the current hawkishness, the CME Fedwatch is building in terminal rates of 5.50% to 5.75%.

    

2. Powell has also underlined that as a policy measure, they would amplify the rate hikes with sustained winding down of the US Fed balance sheet. It is already down by $550 billion since June last year and could go well below $8 trillion by the end of the current calendar year. Of course, on the liquidity front, there will be a balancing act.

    

3. Powell reiterated that the impact on inflation is normally seen in phases. For instance, the first and immediate impact is felt on the rate sensitive sectors like housing, business inventory accumulation etc. That is already visible. However, Powell has also reiterated that there will be no long range guidance and each meeting would be taken up by the FOMC members on a case-by-case basis on the strength of the data flows.

    

4. As Powell has underlined, the problem is not absolute but relative. In other words, the fall in inflation as an outcome of rate hikes has not been as intense or as rapid as the FOMC members had expected. That is where the gap is coming and that has nothing to do with the efficacy of rate hikes as a tool to control inflation. This problem became more pronounced in the January 2023 data. This also means higher terminal rates.

    

5. On the inflation expectations, Powell underlined that it was essential for the Fed to ensure that inflation expectations are anchored to actual inflation figures. That is only possible if the consumers are convinced that the Fed would go all out to control inflation. For now, inflation expectations have stayed anchored.

For now, the next meeting of the FOMC scheduled in late March 2023 is expected to raise interest rates by 25 bps. However, markets are now assigning a 30% probability that the rates in March 2023 may be hiked by 50 bps instead of 25 bps. How Powell and his team will manage the rate hikes, without triggering an economic slowdown remains the million dollar question.