– Still Hopes For ‘Soft Landing’ but Achieving It ‘More Challenging’
By Steven K. Beckner
(MaceNews) – Federal Reserve Chair Jerome Powell said Wednesday that he and his fellow monetary policy-makers must continue to raise short-term interest rates into “restrictive” territory to validate financial market expectations and successfully fight inflation.
Powell, testifying on the Fed’s semi-annual Monetary Policy Report to Congress, said the Fed still hopes to avoid a recession, but conceded achieving a so-called “soft landing” has become harder due to factors beyond the Fed’s control.
Nevertheless, he told the Senate Banking Committee the Fed is strongly committed to bringing inflation back down to its 2% target by softening demand relative to limited supply. Otherwise, he warned, inflation could become “entrenched” and endanger the economy’s longer run health.
At the same time, Powell said he and his colleagues “will be flexible” and adjust monetary policy in response to incoming economic data in a climate of great uncertainty.
The dominant theme of the hearing was inflation, which hit a year-over-year pace of 8.6% in May as measured by the consumer price index. The price index for personal consumption expenditures rose 6.3%.
Powell told the senators there are some hopeful signs that core inflation is decelerating, but vowed the Fed will keep raising interest rates until it sees “compelling evidence” inflation is heading back to 2% – even in the face of recession risks.
Powell’s testimony comes a week after the Fed’s policy making Federal Open Market Committee raised the federal funds rate by 75 basis points to a target range of 1.5% to 1.75% – the FOMC’s third rate hike since it stopped holding rates near zero in March, and the biggest increase since 1994.
The FOMC repeated its expectation that “ongoing increases in the target range will be appropriate.” Underscoring the point, FOMC participants significantly elevated their funds rate projections, anticipating that the funds rate will end this year at 3.4%, up from 1.9% in the March SEP. By the end of next year, Fed officials now see the funds rate rising to 3.8%, up from 2.8% in March, before receding to 3.4% by the end of 2024.
Powell told reporters last Wednesday the FOMC will likely raise the funds rate “either 50 or 75 basis points” at its July 25-26 meeting. He said he and his colleagues concur on the need for monetary policy to become “moderately restrictive.”
He and his colleagues now forecast slower GDP growth and higher unemployment as they restrain demand for goods in short supply to curb inflation far in excess of their 2% target. Even so, the Monetary Policy Report vows the Fed it is “strongly committed to restoring price stability.”
Powell, in his post-FOMC press conference, said the Fed still aims to sustain a “strong labor market” while bringing inflation down to 2% but conceded achieving a so-called “soft landing” has become “more challenging” because “many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not.”
Accordingly, the FOMC stopped saying that “with appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2% objective and the labor market to remain strong.”
Although the economy has not been officially declared to be in recession, there are proliferating signs of slowing. Soaring mortgage rates are cooling the once hot housing market; existing home sales fell for a fourth straight month by 3.4% last month to a two-year low. Manufacturing output declined 0.1% in May. The 1.5% first quarter drop in GDP was considered something of a fluke, but the Atlanta Federal Reserve Bank estimates zero growth for the second quarter.
Labor markets are also showing signs of slowing (fewer job openings; more jobless claims, slower wage growth), but Powell repeated Wednesday that labor markets are “extremely tight,” although he said, “we’re seeing the beginnings of job growth slowing to more sustainable levels.”
Although wages are rising at a pace that is “not consistent with 2% inflation,” he said there is “some evidence that they’re flattening out.”
Powell’s Senate Banking Committee testimony largely echoed what he told reporters after the FOMC meeting a week earlier.
As senators tried to feel him out on future Fed rate moves, Powell said “the market has been reading our reaction function reasonably well …. We will see continued progress – expeditious progress — toward higher rates .…”
He noted that FOMC participants now see the funds rate moving to a “moderately restrictive” range of “between 3 and 3 ½%.”
Powell suggested Wall Street is doing the Fed’s work by tightening financial conditions in anticipation of further rate hikes, but implied the Fed must follow through and actually raise rates as expected.
“We’re getting a lot of tightening well in advance of policy changes …,” he said, adding that the yield curve shows “very substantial rate hikes are already priced in .… All out the curve of debt maturities … (yields) have moved up to reflect rate increases we haven’t made.”
“It’s really only at the very short end of curve … where (real) rates are negative,” he added.
Despite three rate hikes totaling 150 basis points since mid-March, “our policy rate is still at a relatively low level …,” Powell said, adding, “we want to get up to a more neutralish level even more expeditiously than we had been .…”
At last week’s FOMC meeting, Powell said the Committee’s “concern was not with the (rate) level, but the speed” of rate increases.
He said he “was persuaded it was important to make this move now … not telegraph six weeks later… because of where we are with inflation … coming in above target .…” The FOMC decided it “would be appropriate to move more aggressively.”
At 1.5 to 1.75% the funds rate is below the FOMC’s estimated 2.5% neutral rate, and “we think it’s appropriate to move above neutral to a moderately restrictive level because this is very high inflation …,” Powell said.
“We need to get inflation on a path back to 2%, and the way we’re going to do that is raise interest rates …,” he went on.
After saying the path of rates will depend on incoming data, Powell added, “We’re strongly committed to getting inflation down to 2% … (but) we’re going to be flexible.”
A similar comment was contained in the Fed chief’s prepared testimony: “Making appropriate monetary policy in this uncertain environment requires a recognition that the economy often evolves in unexpected ways. Inflation has obviously surprised to the upside over the past year, and further surprises could be in store. We therefore will need to be nimble in responding to incoming data and the evolving outlook .….”
Those comments seemed to leave open the possibility of either more or less aggressive rate hikes, depending on the pace of inflation and on the economic outlook.
Asked about the possibility of a 100 basis point rate hike, Powell said he would “never take something off the table for any and all purposes.” He said the FOMC “will make whatever moves we think is appropriate to restore price stability.”
Powell was peppered with questions and warnings about monetary tightening tipping the economy into recession. In a series of responses, he did not rule out a downturn, but like Treasury Secretary Janet Yellen, a former Fed colleague, he suggested it is not inevitable.
For starters, he said that, despite signs of slowing, “the American economy is very strong and well positioned to handle tighter monetary policy.”
The Fed is seeking “lower demand growth,” Powell said. “I don’t know that demand actually has to go down, which would be a recession .… We’re slowing down growth…”
A recession is “certainly a possibility,” but “that’s not our intention,” he said, reiterating that the Fed’s objective is to achieve 2% inflation while keeping “a strong labor market.”
But Powell hedged when asked whether such a “soft landing” is still possible.
“It is our goal, but it’s going to be challenging,” he said, adding that a soft landing “has been made significantly more challenging” by the war in Ukraine, China’s anti-Covid lockdown and other factors “beyond our control.”
“We never said it was going to be easy …,” Powell said, “and the events of the last few months have made it more challenging.”
“Nevertheless, there are paths” to a soft landing,” he said. “It could happen” if the Fed is able to moderate demand and bring it back into balance with available supply. “We’ll find out.”
“I don’t see the likelihood of recession being particularly elevated right now…,” Powell said in response to another question. “I’d say the U.S. economy for now is strong, spending is strong, consumers are in good shape, businesses are in good shape …..”
But he acknowledged, “weaker outcomes are certainly possible.”
Though conscious of the risk of recession, Powell said “the other risk though is that we not manage to restore price stability… (and) allow inflation go get entrenched .…”
Letting high inflation continue would “hurt people in lower income spectrum… more than anyone…,” he said. So “we can’t fail on that task. We have to get back to 2% inflation to get the kind of labor market we want.”
In other comments, Powell was vague about outright sales of mortgage backed securities. He said they will not be considered until balance sheet reduction is “well under way.”
“We may well need to sell MBS at a future date,” he added. He said the decision would not be based upon “unrealized losses” on bonds in the Fed’s portfolio.