– FOMC Might Ease Earlier If Saw ‘Unexpected Weakness’ in Labor Market
– Thinks ‘Neutral’ Federal Funds Rate Has Risen
– Gives No Indication Fed Ready to Halt QT
– Dodges Questions About Tariff Impact on Economy, Monetary Policy
By Steven K. Beckner
(MaceNews) – With inflation still running too hot in an economy growing above trend close to full employment, Federal Reserve Chair Jerome Powell held out little hope for near term interest rate relief in a congressional appearance Tuesday.
After 100 basis points of rate cuts from September through December, monetary policy is “significantly less restrictive,” so the Fed does “not need to be in a hurry to adjust our policy stance,” Powell told the Senate Banking Committee.
The Fed could ease credit if the labor market “weakens unexpectedly,” but if inflation fails to fall toward its 2% target in a climate of strong economic activity, the Fed could “maintain policy restraint for longer,” he said in the first of two days of testimony on the Fed’s semi-annual Monetary Policy Report to Congress.
Powell said he agrees with many of his Fed colleagues that the so-called “neutral” federal funds rate has risen, implying less need to cut the actual funds rate.
He indicated the Fed is also in no hurry to stop shrinking its bond holdings through “quantitative tightening.”
Powell refused to be drawn into criticism of President Trump’s trade policies.
Powell’s testimony, which will be reprised Wednesday before the House Financial Services Committee, comes two weeks after the Fed’s rate-setting Federal Open Market Committee left the key federal funds rate unchanged in a target range of 4.25% to 4.5%, while continuing to shrink the Fed’s balance sheet.
The Committee’s policy statement left the door open to a resumption of rate cuts at some point, although its policy statement was perceived as being slightly more “hawkish” in excising former assertion that “inflation has made progress toward the Committee’s 2% objective,”
Powell said afterward that the FOMC had concluded that, after 100 basis points of rate cuts from September to December, “it’s appropriate we do not be in a hurry to make further adjustment.” He used nearly the exact language in his Tuesday testimony.
Since the meeting, data showing a combination of persistently high inflation and relatively strong employment seem to have given little impetus to further rate moves.
The Monetary Policy Report, which was released Friday, reflects this sense of equilibrium. Regrading inflation, it says, “recent progress has been bumpy and inflation remains somewhat above 2%.”
Meanwhile, it observes, “the labor market remains solid and appears to have stabilized after a period of easing ….. Given the further re-balancing of labor demand and supply last year, the labor market no longer appears especially tight. Reflecting this further balancing, nominal wage gains continued to slow in 2024 and are now closer to the pace consistent with 2% inflation over the longer term.”
Testifying on the report on behalf of the FOMC, Powell reiterated that he and his fellow policymakers are content to wait for a while before resuming monetary easing.
“With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance,” he said in prepared testimony.
As he has multiple times before, Powell allowed for some policy flexibility.
“We know that reducing policy restraint too fast or too much could hinder progress on inflation,” he said. “At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment …..”
“If the economy remains strong and inflation does not continue to move sustainably toward 2%, we can maintain policy restraint for longer,” he continued. “If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we can ease policy accordingly.”
“We are attentive to the risks to both sides of our dual mandate, and policy is well positioned to deal with the risks and uncertainties that we face,” he added.
Echoing the FOMC’s Jan. 29 statement, Powell said, “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the FOMC will assess incoming data, the evolving outlook, and the balance of risks.”
Elaborating in response to questions from senators about when the Fed might resume cutting rates, Powell said, “Overall the economy is strong, growing 2 ½ last year. The labor market is also very solid, unemployment rate at 4% — quite a low level. Inflation last year was 2.6% for the year. So, we’re in a pretty good place with this economy.”
“We want to make more progress on inflation, and we think our policy rate is in a good place, and we don’t see any reason to be in a hurry to reduce it further,” he went on.
Responding to one of many questions about how Fed policy is affecting the level of mortgage rates and the cost of housing, Powell said, “It’s true that mortgage rates have remained high, but that’s not so directly related to the Fed’s rate. It’s really related more to the long-term bond rates, particularly the 10-year Treasury, the 3-year Treasury for example, and those are high for reasons not particularly closely related to Fed policy.”
Mortgage rates “may remain high,” he said, but “once we lower rates, and kind of rates return to a lower level, mortgage rates will come down. I don’t know when that will happen, and even when it does happen we’re still going to have a housing shortage in many places.”
Powell was also asked about the level of the “neutral” funds rate, the hypothetical rate at which monetary policy is neither stimulative nor contractionary – a topic that has gained increased currency in monetary policy circles lately.
With downside risks having “diminished” and the labor market now “very strong,” he replied, “my view is that the neutral rate will have risen meaningfully from a very, very low – historically low — before the pandemic .…Yes, I think it’s moved up, and many of my colleagues feel that way too.”
The “longer run” “neutral rate” includes the 2% inflation target plus an estimate of the real equilibrium short-term interest rate (r*). Many economists and Fed officials believe the real rate has risen because of faster productivity growth, among other reasons, and this belief is reflected in the Fed’s quarterly Summary of Economic Projections,
After dramatically lowering their estimate of the “longer run” “neutral rate” after the financial crisis, FOMC participants have increased it by six tenths to 3.0% over the past three years, with most of the upward revisions coming in the past year.
This has important policy implications. To the extent Powell & Co. believe the neutral funds rate has risen, they can justify fewer reductions in the actual funds rate.
Asked about the Fed’s balance sheet reduction strategy, Powell said, “we intend to slow (QT) then stop … when reserve balances are consistent with ample reserves.” But he said, at this time, “reserves are still abundant ….”
To decide when to stop shrinking the balance sheet, Powell said, “we basically are going to be looking at reserve conditions” and “trying to stop a little bit above where (reserves are) ample …. we are meaningfully above that now…”
He added, that “we can’t know demand for reserves other than observing conditions in the market” and that the Fed wants to “keep a buffer” above the “ample” reserves level.
Ever since the president declared on Jan. 23 that he would “demand that interest rates drop immediately” if oil prices fall, there have been jitters on Wall Street about Trumpian threats to the Fed’s independence, although his Treasury Secretary Scott Bessent has sought to dampen such concerns.
Powell once again defended Fed independence, saying “we can do our job” better by refraining from taking actions that favor one political party or the other, but otherwise declined to comment on Trump pronouncements. He did say that it would not be within the law for Trump to fire him or other Fed policymakers.
Markets have also been unsettled by Trump tariff threats and actions against major U.S. trading partners, but here again Powell treaded lightly (and agnostically) in the face of repeated questions about tariffs.
“It really does remain to be seen what tariff polices will be implemented…,” he said. So “it’s unwise to speculate…it’s so hard to say what will happen….”
Powell added that “it’s not just tariffs” that will impact the economy, “it’s fiscal policy, immigration policy, regulatory policy ….. It will all go into the mix .…”
The Fed chief indicated, however, that he’s not entirely unsympathetic with Trump’s combative trade strategy. While “the standard case for free trade … logically still makes sense,’ he said “it doesn’t work that well when we have one very large country that doesn’t play by the rules…”
But he quickly added, “our job is to react in a thoughtful way and make monetary policy to meet our dual mandate.”
Powell’s testimony followed a string of largely favorable economic data.
This past Friday, the Labor Department reported that the unemployment rate fell from 4.1% to 4% in January. Non-farm payrolls grew a less than expected 143,000, but prior months job gains were revised up by 100,000. Average hourly earnings grew a faster 0.5%, leaving them up 4.1% from a year earlier – up from 3.9% in December.
The previous Friday, the Commerce Department had reported that its price index for personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, rose 2.6% from a year earlier in December, two tenths higher than in November. The more closely watched core PCE was up 2.8% for the second straight month — well above the Fed’s target.
Gross domestic product has been growing at a 2.5% pace, well in excess of the FOMC’s estimate of the economy’s non-inflationary growth potential, leading some Fed officials to maintain that the funds rate is already near “neutral.”
On neither side of the Fed’s dual mandate of “maximum employment” and “price stability” does there appear to be a compelling case for changing rates at this stage.
Inflation expectations are a major concern for the Fed, and Powell repeated his familiar refrain that inflation expectations “remain well-anchored,” but his assertion was somewhat belied by recent findings of the University of Michigan’s latest consumer sentiment survey. It showed one-year inflation expectations surging from 3.3% to 4.3% in February – highest since November 2023.
The New York Fed’s January 2025 Survey of Consumer Expectations, released Monday, found that “inflation expectations were unchanged at the short- and medium-term horizons,” but “increased at the longer-term horizon.” While “median inflation expectations were unchanged at 3.0% at both the one- and three-year-ahead horizons,” the survey found that “median five-year-ahead inflation expectations rose by 0.3 percentage point to 3.0% in January.”
The survey also found a deterioration in its gauge of uncertainty about future inflation. Although median inflation uncertainty was unchanged at the one-year horizon and declined at the three-year horizon, it “increased at the five-year horizon.”
Earlier Tuesday, Cleveland Federal Reserve Bank President Beth Hammack, who voted against the Dec. 18 rate cut, said the funds rate will likely need to stay where it is “for some time.”
“Given the economy’s momentum heading into 2025, and with a healthy labor market, we have the luxury of being patient as we assess the path forward for inflation,” she said. “We have made good progress, but 2% inflation is not in sight just yet. As long as the labor market remains healthy, I am looking for broad-based evidence that inflation is sustainably returning to 2 percent before adjusting policy further.”
Hammack said, “the risks to the inflation outlook appear skewed to the upside” amid heightened policy uncertainty. What’s more, she maintained that “monetary policy is only modestly restrictive.”
So she said “it will likely be appropriate to hold the funds rate steady for some time. A patient approach will allow us to assess the health of the labor market, whether inflation is returning to 2% on a sustained basis, and how the economy is performing in the current rate environment.”