March 21, 2023


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Powell changed everything this week when it comes to the market’s view of interest rates

  • Federal Reserve Chairman Jerome Powell has set a new paradigm for how the central bank views its policy path, one that will obviously see higher interest rates for a longer period of time.
  • Markets now aggressively expect a half point increase in March and a peak, or final interest rate, of approximately 5.75% before the Fed ends.
  • What has changed is the January inflation data, as well as signs that the labor market remains remarkably strong despite the Fed’s efforts to slow it.

Federal Reserve Chairman Jerome H. Powell testifies before the House Financial Services hearing on the “Federal Reserve Semi-Annual Monetary Policy Report” on Capitol Hill in Washington, US, March 8, 2023.

Kevin Lamarck | Reuters

Federal Reserve Chairman Jerome Powell’s speech to Congress lasted only a few minutes, but it changed everything.

In those remarks, the central bank leader laid out a new model for how the Fed views its policy path, one that will apparently see higher interest rates for a longer period of time than previously thought.

The consequences have forced the market, which has long been looking out for the Fed in its fight against inflation, to readjust its views to align more with policymakers who have warned against a higher interest rate approach for longer.

Art Hogan, chief market strategist at B.V. “It took Jay Powell, over the course of a very brief prepared statement and question and answer, to cement those expectations in higher esteem.”

As part of his semi-annual commissioned testimony on monetary policy, Powell spoke on Tuesday before the Senate Banking Committee and then the next day before the House Financial Services Committee.

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As appearances draw near, markets were eyeing the Fed to raise its benchmark interest rate by 0.25 percentage point at its meeting later this month, and then maybe two more moves before stalling, with the end point around 5.25%.

That changed after Powell’s appearance, during which he warned that if inflation data remains strong, he expects rates to rise “higher than previously expected” and perhaps faster than a quarter of a point at a time.

Markets now aggressively expect a half point increase in March and a peak, or final interest rate, of approximately 5.75% before the Fed ends.

So what has changed?

Basically, it was inflation data for January as well as signs that the labor market remains remarkably strong despite the Fed’s efforts to slow it down. This made Powell, who only weeks ago spoke of the “anti-inflationary” forces at play, change his stance and start talking firmly again about monetary policy.

“It modifies the statements coming in, which the entire board should be doing,” Hogan said. “If the realities change again with the February and March data, it will probably become flexible in that aspect and not push this too far to the point where they need to break something.”

In fact, Powell said he’ll be watching a pivotal set of upcoming data closely – Friday’s non-farm payrolls report, followed by next week’s look at consumer and producer price indices.

Economists at Goldman Sachs are sticking to their forecast for a quarter-point increase at the March 21-22 FOMC meeting, but acknowledge that it’s a “close call” between that and a half-point.

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If the Fed were forced to lean in the more aggressive direction, Goldman warned in a client note that it could have market implications, with equities selling “more aggressively” and downward pressure on commodities, as well as upward pressure on the dollar.

Powell faced some questions this week about the Fed’s anti-inflationary strategies.

Some of the more progressive lawmakers like Senator Elizabeth Warren (D-Massachusetts) and Representative Ayanna Pressley (D-Massachusetts) have charged that raising prices would result in 2 million layoffs and disproportionately hurt working-class families. Powell countered that inflation also hits those at the bottom of the income spectrum.

“This is what he’s supposed to do,” Joseph Brosolas, chief economist at RSM Consulting, said of Powell’s shifting political stances. “Jay Powell is a punching bag in Washington at this point. He’s going to take the blame for price stability. If he does it well, he’ll be revered in years to come. People will talk highly of him.”

Brosolas is among those who believe the Fed should accelerate its fight against inflation by raising interest rates by half a point.

However, he said policymakers could be influenced by a potentially softer jobs report and inflation data next week that reverse course and show price increases easing. Economists expect the number of jobs to have grown by 225,000 in February, according to Dow Jones, and there is a widespread belief that January’s increase of 517,000 will be revised downward in this report, possibly significantly.

“The economy is very resilient at this point,” Brosolas said. “They need to generate enough sluggish employment to calm the economy.”

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Slack was less clear on this week’s Labor Department report on job vacancies in January, which outnumbered available workers by a margin of 1.9 to 1.

Such data could prompt the Fed to tighten further, according to economists at Nomura. The company said future actions could include adjustments to the Fed’s program to reduce its bond portfolio, with one option being to remove the $95 billion monthly reduction cap currently in place.

For now, the markets continue to price in at higher rates.

Although Powell made a special point on Wednesday to stress that no decision has yet been made on the March interest rate move, markets have basically ignored him. Traders in the futures market were finalizing a price of 5.625% later this year, much higher than before Powell spoke.