Jerome Powell, Chairman of the Federal Reserve, during a House Financial Services Committee hearing in Washington, D.C., on June 21, 2023.
Nathan Howard | Bloomberg | Getty Images
Federal Reserve Chair Jerome Powell heads to Capitol Hill on Wednesday with markets intent on getting more clarity on how the central bank plans to move forward with monetary policy this year.
The past few months have seen a changing dynamic between financial markets and the Federal Reserve over the pace and timing of expected interest rate cuts this year. Markets have been forced to adjust their collective view from an ultra-lenient central bank to a more cautious and deliberate one.
As he delivers his congressionally mandated testimony to the House on Wednesday and the Senate on Thursday, Powell will be tasked with providing a clearer vision — not unsettling the situation on tense Wall Street.
“The question now for the market is to gather any information about when the Fed will start implementing interest rate cuts and how many,” said Quincy Crosby, chief global strategist at LPL Financial. “It won't necessarily answer that. But if there's any change, any nuance, that's what the market wants to see.”
Central to the question of how the Fed will act going forward is its view on inflation and how Powell expresses that. In recent weeks, he and others have expressed satisfaction with the trend in prices along with concerns that risks still lurk, saying it is too early to ease monetary policy.
Markets currently expect the Fed to begin cutting in June and will issue the equivalent of four quarter-point cuts in total this year, according to futures market prices measured by CME Group. Policymakers in December indicated three cuts and most avoided providing a timeline.
Mixed signals complicate the message
On the issue of inflation, the data has been mostly cooperative.
Inflation readings in the latter part of 2023 showed a clear trend toward the Fed's 2% target. However, January delivered a jolt, showing that consumer prices, especially shelter costs, remained stubbornly high and pose a threat to the trend.
Powell will have to carefully piece together the latest trends when he speaks first before the House Financial Services Committee on Wednesday, then before the Senate Banking Committee the next day.
“The message will often not be ‘mission accomplished,’ but ‘we have made a lot of progress, and we expect interest rate cuts to come,’” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. “And that, to me, is what I think the message will be.” “Centralization.”
Powell's testimony before Congress comes at a sensitive time for markets: After breaching historic highs, major stock averages sold off this week amid lingering concern about where interest rates are headed and the suddenly uncertain outlook for a few big tech names that have been driving higher prices.
Both conditions are worrisome for policymakers. Large jumps in risk asset prices could reflect loose financial conditions that could prompt the Fed to stick to its policies, while a less certain environment could raise concerns about remaining at too high levels for too long.
Powell “cannot deviate at all from the data-driven approach, but we really want the rate cuts the committee has committed to,” wrote Stephen Ricciuto, chief U.S. economist at Mizuho Securities. “Sharp fluctuations in financial conditions can easily serve at cross-purposes with the committee’s goal: maintaining tight labor market conditions while also keeping inflation expectations and long-term interest rates healthy,” he said, referring to the policy-setting Federal Open Market Committee. . .
Political concerns
There are also other dynamics facing Powell. Many economists, including LaVorgna, see business conditions weakening despite the apparent strength of the 3.7% unemployment rate. Also, the recent astonishing rise in cryptocurrency prices indicates an unchecked risk that could indicate a lot of liquidity has been drained around the system.
In fact, Atlanta Fed President Rafael Bostic on Monday released an op-ed in which he expressed concern about the potential “pent-up exuberance” that could be unleashed after interest rate cuts begin.
“We do not believe that monetary policy per se is loose, but the Fed and Powell should question this nonetheless, given this existing ‘residue’ of speculation,” strategists at Macquarie said in a note to clients on Tuesday. “The point is that small bouts of speculation that come out of nowhere should make it difficult for the Fed to look dovish at this point.”
Finally, there are political considerations.
Along with the usual pressure that comes during presidential election years, there have been calls in Congress for Powell and his colleagues to start cutting interest rates. Sen. Elizabeth Warren, Democrat of Massachusetts, not a fan of Powell to begin with, in January called for the Fed to start lowering interest rates because rate hikes are particularly painful for low-income families.
They will have the opportunity to discuss the issue on Thursday, as Warren is a member of the Senate Banking Committee.
LaVorgna said Powell needs to “explain why the Fed needs to address interest rates in anticipation of where inflation is likely not right now.” “You're damned if you do, damned if you don't. So, I think you need a very solid framework.”
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