Cooling in the economy appears to have “partly reversed” based on recent data on jobs, consumer spending, production and inflation, Federal Reserve Chair Jerome H. Powell told Congress on Tuesday, suggesting that the central bank could keep raising interest rates more aggressively than expected just a few months ago.
The remarks, given at the start of two days of testimony on Capitol Hill, underscore how quickly the economy continues to shift three years since the pandemic began. They also mark a clear signal from the economy’s most powerful policymaker that the Fed would consider sharper interest rate hikes if officials thought the economy was moving in the wrong direction.
Stocks dived into the red Tuesday. The Dow Jones industrial average shed 574 points, or 1.72 percent. The S&P 500 lost 1.53 percent, and the Nasdaq 1.25 percent.
Fed leaders will convene again March 21 through March 22, at which point they’ll have more data to analyze. Fresh jobs figures covering February will be released Friday. And next week, a new inflation report will help explain whether progress on the Fed’s inflation fight is slowing.
When officials assemble later this month, they will announce the size of their next rate hike and release a fresh set of economic projections on inflation, the unemployment rate, economic growth and the future path for the baseline interest rate controlled by the central bank. The expectation is that there will be notable revisions since the last set of projections, from December, including in where interest rates will eventually settle.
“The data we’ve seen so far — and we still have significant data to see before the meeting — suggests the ultimate [federal funds] rate that we will write down may well be higher than what we wrote down in December,” Powell said.
The Fed makes its decisions independent from politics, but it comes under significant pressure from both parties. Republicans have long criticized the Biden administration for its big spending packages, and they slammed the Fed last year for being slow to raise rates. Democrats have warned the Fed against going too far and causing such a slowdown that business announce widespread layoffs and workers suffer.
Meanwhile, Republicans and Democrats on Capitol Hill are clashing over the debt ceiling. Powell told lawmakers that the consequences of not raising the debt limit “are hard to estimate, but they could be extraordinarily adverse and could do long-standing harm.”
For much of last year, the Fed sprinted to catch up to inflation that soared to 40-year highs, hiking interest rates by 4.5 percentage points in less than a year. Once rates were high enough to actively slow the economy, the Fed decided to slow its pace, scaling down from a half-point increase in December to a quarter-point in its first meeting of 2023.
The plan then was to stick to a few more quarter-point increases until pausing rate hikes altogether, so the full weight of the Fed’s decisions last year could work through the economy. But in a matter of weeks, that plan has been cast into doubt by economists and Fed watchers, who point to a recent crop of hotter-than-expected data and argue that the Fed might have to scale up once again.
In an analyst note, Derek Tang, an economist at research firm LH Meyer/Monetary Policy Analytics, predicted a half-point hike in two weeks, arguing that “the burden of proof looks significantly different” based on Powell’s testimony.
“Powell’s comments make it sound as though they need to be convinced not to speed the pace up,” Tang wrote. “The presumption that’s been established is that they will hike 50 in March, unless they are convinced otherwise.”
If the Fed did scale back up to a half-point hike, central bankers would be going against many of their messages from the past few months. Officials have argued that smaller, quarter-point increases give them more flexibility as they tiptoe up to the federal funds rate’s ultimate level. Rate hikes also operate with long lags, and policymakers have warned about the risks of going too far, too fast, especially since the Fed has the dual responsibility of controlling prices and supporting the labor market.
Fed leaders have consistently said they will make decisions based on all the data before them, and they typically don’t commit to specific moves weeks before a policy meeting. But Powell’s remarks appeared to answer growing anxiety that the Fed risks falling behind in its inflation fight once again if it sticks to its plans for quarter-point hikes.
Inflation has fallen from last summer’s peak but remains well above normal levels. And the Fed’s inflation fight appears to be getting harder. January prices eased over the year before, but only slightly, and the concern now is that the remaining sources of inflation will be more difficult to root out.
At the top of that list is inflation that stems from the hot labor market, which can be exacerbated by wage pressures and mismatches in the number of job openings vs. the number of people looking for work. That has Fed officials focused on inflation in service industries like health care and hospitality.
A hot labor market is usually a boon for workers, giving them leverage and negotiating power for higher pay. But Democrats have raised alarms that high rates could dampen the economy so much that workers lose their jobs and people pull back on spending. Sen. Elizabeth Warren (D-Mass.) asked Powell what he would say to millions of people who could be out of work if the Fed keeps raising rates and causes a downturn.
Powell responded by saying that inflation hurts everyone and that the Fed would not be doing its job if it gave up the fight now. “Will working people be better off if we just walk away from our jobs and inflation remains 5 or 6 percent?” he said.
So far, though, the job market has shown remarkable resilience. Employers added a whopping 517,000 jobs in January, shattering expectations and upending impressions that the labor market was cooling. In a shock to observers, the unemployment rate fell to 3.4 percent, a low not seen since May 1969.
Retail sales are also strong, and many employers are desperate to hire. Whether that can keep up as borrowing costs climb higher and higher remains to be seen.
“I think nothing about the data suggests to me we’ve tightened too much,” Powell said. “Indeed, it suggests we still have work to do.”