After the Federal Reserve’s December meeting, Chair Jerome Powell made a conspicuous shift in how he discussed the trade-off between wanting to see greater improvement in the labor market and tolerating persistently elevated consumer price growth.
Sure enough, in his confirmation hearing at the Senate Banking Committee on Tuesday, Powell made the same point again. “In a way, high inflation is a severe threat to the achievement of maximum employment,” he said. “We think wages moving up is generally a good thing, but if you look back through history, there are times when wages have moved up in a way that has fostered persistent inflation, and that hurts everyone.”
This is a deft move on the part of Powell, who earned respect among both Democrats and Republicans for the Fed’s response to the onset of the Covid-19 pandemic. Yet as of late, members of both parties agree that the central bank has fallen behind the curve in containing the highest levels of U.S. inflation in decades. It’s a particularly agonizing headache for the Fed, which had explicitly pledged to keep interest rates near zero until the labor market had reached a level consistent with “maximum employment.” The economy remains millions of workers short of February 2020 levels, even with a 3.9% jobless rate as of December.
So Powell did the only thing he could do in the situation: Make the case that imminent, gradual interest-rate increases will help, rather than hurt, the overall labor market. It’s a fine line to walk, given that tightening monetary policy by definition dampens demand.
“We can begin to see that the post-pandemic economy is likely to be different in some respects,” Powell said in his prepared remarks. “The pursuit of our goals will need to take these differences into account. To that end, monetary policy must take a broad and forward-looking view, keeping pace with an ever-evolving economy.”
Of course, Powell is quite clearly still a dove at heart, and he made that apparent throughout his testimony. He’s holding out hope that supply constraints will recede so that the Fed doesn’t have to fix the economy’s supply-demand imbalances solely through the demand side. This just so happens to be a view shared by President Joe Biden, who noted in a speech on Friday that “if car prices are too high right now, there are two solutions: You increase the supply of cars by making more of them, or you reduce demand for cars by making Americans poorer. That’s the choice. Believe it or not, there’s a lot of people in the second camp.”
That’s a bit hyperbolic, considering the Fed’s current projections don’t even have the fed funds rate at the “neutral” level of 2.5% by the end of 2024. With inflation-adjusted interest rates still deeply negative and a balance sheet that’s still growing, it’s hard to make the argument that the central bank is on the verge of constraining the economy meaningfully.
But make no mistake: Monetary tightening is coming soon. Powell was careful not to give anything away about the timing of the first interest-rate increase, but his colleagues are doing it for him. So far this week, Atlanta Fed President Raphael Bostic said that starting to raise rates in March may be appropriate, Cleveland Fed President Loretta Mester said she’d support moving rates higher in March if the economy looks like it does now, and Kansas City Fed President Esther George said it’s time to transition policy to a more normal stance.
Still, stocks gained and Treasury yields dipped in the wake of Powell’s testimony in what seemed to be a relief rally after Goldman Sachs Group Inc. and others made headlines by floating the idea of four interest-rate increases in 2022. Compared with that scenario, the Fed chair seemed dovish. “All members of the committee see interest rate increases coming this year — the median was three — but it’s going to depend on data,” Powell said. That is to say, if inflation quickly comes back close to 2% later this year, the central bank may pause any further tightening. Of course, the flip side holds true as well. “There are risk on both sides,” Powell said.
That’s not helpful for investors looking to gauge the market’s next moves. But Powell’s comments were meant entirely for lawmakers on Capitol Hill at the start of a midterm election year. For Democrats, he pledged that the central bank would remain committed to seeing job gains reach segments of the population that have historically taken longer to find employment. For Republicans, he vowed that policy makers would bring about a return to price stability.
There’s only one way to reconcile both of those commitments: through the argument that Powell continues to make about inflation threatening maximum employment. It helps that he’s correct. But it won’t make navigating a potentially choppy 2022 any easier atop the central bank.
More From Other Writers at Bloomberg Opinion:
• Will Biden’s Fed Picks Alter Its Hawkish Path?: Moss & Chappatta
• Fed Has to Run Triple Option as Time Runs Out: Mohamed El-Erian
• The Federal Reserve Needs to Get a Lot More Hawkish: Bill Dudley
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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