Jerome Powell, the Federal Reserve Chair, spoke to the Senate Banking Committee this morning and into the afternoon today.
In his semi-annual testimony, Powell highlighted that inflation risks still lean to the upside, the labor market remains extremely tight, and the Fed is prepared to not only increase the pace of interest rate hikes but keep the Fed’s benchmark rate higher for longer. Powell’s hawkish comments set off a huge bout of USD strength across the G10 board as investors digested this news.
While Powell has always leaned more hawkish than the average FOMC participant, his comments today are a marked departure from the relatively even messaging the Fed has kept since it slowed its hiking pace to 25 basis points at the February meeting. Ultimately, his message is that more aggressive policy action is needed from the Fed moving forward to bring extraordinarily resistant inflation back down to the long-run goal of 2 percent. After January economic data holistically came in far above expectations, it’s clear that the Fed cannot stay the course it set through Q4 of last year and must take more drastic action.
This testimony marks Powell’s most hawkish remarks since his speech at the Jackson Hole conference last August, and markets responded immediately – G10 currencies fell an average of 1.1% against the US Dollar in the hours following his comments. Fed swaps are now pricing in an average of a 38 basis point hike at the next Fed meeting on March 22, meaning the probability of a 50 basis point hike is now above 50 percent. Predictions for the Fed’s terminal rate at the end of this tightening cycle are now above 5.5%, as Powell stated, “[t]he historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”
However, it remains crucial to note that the Fed’s March decision is heavily contingent on a slew of economic data for the month of February due out of the US over the coming days. Non-farm payroll numbers will be released Friday morning, and inflation data is due on Tuesday. In addition, Friday’s labor market data promises to be a major market mover as current estimates shoot for an additional 224,000 jobs. This release will determine whether January’s huge gain was a one-off or something more entrenched in the economy. Reading between the lines, it’s likely that Powell and the greater FOMC believe January’s numbers were not a fluke, given the change in tone today.
Highlighted several times was the need Powell sees for “labor market softening,” as the labor market remains uncomfortably tight for the Fed’s inflation target, and by most estimates, above what economists call “maximum employment.” Though he stopped short of saying unemployment needs to rise dramatically, the writing is on the wall – it’s hard to see in the short term what could soften the labor market quickly outside of rising unemployment. Powell’s attempts to walk the line on labor put him under intense pressure from Senator Elizabeth Warren, who said that Fed policies would put millions of people out of work.
As we wrote a few weeks ago, economic conditions in the “post-pandemic” United States present unique challenges for governing bodies to navigate. Powell himself has acknowledged that though inflation trends the last two years were originally triggered by the global supply chain crisis, there are a couple other factors at play that the Fed cannot truly control: namely, over a million people dead from COVID-19, and unprecedented corporate profits reported over the last few quarters. Through the next several meetings of the Federal Reserve, their attempts to tighten monetary policy may not be enough to do the job.
Looking forward to Friday and next week, any upside surprise in either employment or inflation data from the US will likely continue this current run of dollar strength, though potentially at the cost of economic security for the average American. As Powell noted, returning to a 2 percent inflation target will be bumpy, and US consumers may well bear the burden. As of now, the Fed’s tightening cycle is likely to continue through most of the year. It’s fairly unlikely that the United States will enter a technical recession, but that alone does not mean any pressure on the American economy. The saving grace for the Buck remains that nearly every other major economy and currency finds itself under similar pressure.