Fed Chair Powell heads to Capitol Hill together with his fingers full

Federal Reserve Chairman Jerome Powell testifies during the Senate Banking Committee hearing entitled The Semiannual Monetary Policy Report to the Congress in Washington, United States, March 3, 2022.

Tom Williams | Reuters

Federal Reserve Chair Jerome Powell will appear before Congress with a tall order: convincing lawmakers that he is committed to bringing down inflation without bringing the rest of the economy to its knees.

The markets were in suspense, wondering if he can pull it off. Sentiment has been more upbeat in recent days, but that could quickly turn the other way should the central bank governor stumble during his bi-annual monetary policy address this week.

“He needs to be threading the needle here with two messages,” said Robert Teeter, Silvercrest Asset Management’s head of investment policy and strategy. “One of them reiterates some of his comments that there has been progress on inflation.”

“The second thing is really persistent about the prospects for continued high interest rates. He will likely reiterate the message that rates will remain high for some time until inflation is clearly resolved,” Teeter said.

If he takes that stance, he’s likely to face some pressure, first from the Senate Banking Committee on Tuesday, followed by the House Financial Services Committee on Wednesday.

Democratic lawmakers in particular are concerned that the Powell Fed’s determination to fight inflation risks dragging down the economy, particularly those at the bottom of the wealth spectrum.

Slowly out of the blocks

The Fed has raised its benchmark interest rate eight times in the past year, most recently by a quarter of a point early last month, bringing the federal funds rate to a target range of 4.5% to 4.75%.

Markets have also been torn between wanting the Fed to cut inflation and worrying that it might go overboard. The central bank’s slow start in tackling the rising cost of living has fueled fears that there is virtually no way to bring prices down without triggering at least a mild recession.

“Inflation is a harmful problem. It was made worse by the Fed not recognizing it in 2021,” said Komal Sri-Kumar, President of Sri-Kumar Global Strategies.

Sri-Kumar thinks the Fed should have acted earlier and more aggressively – for example, with a 1.25 percentage point hike in September 2022, when CPI inflation was at an 8.2% annual rate. Instead, in December, the Fed began scaling back the scope of its rate hikes.

Now, he said, the Fed will likely need to raise interest rates to around 6% before inflation eases, and that will do economic damage.

“I don’t believe in this no-landing scenario,” Sri-Kumar said, referring to a theory that the economy will neither experience a “hard landing,” which would be a steep recession, nor a “soft landing,” which would be a flatter downturn .

“Yes, the economy is strong. But that doesn’t mean you’ll slide by without a recession,” he said. “If you have a no-landing scenario, you will accept 5% inflation and that is politically unacceptable. He has to work to bring down inflation, and because the economy is so strong, it will be delayed. But the more lag you have in the recession, the deeper it will be.

‘Ongoing increases’ ahead

For his part, Powell will have to find a landing point between the competing political views.

A monetary policy report to Congress released by the Fed on Friday, which serves as a prelude to Powell’s testimony, reiterated commonly used language that policymakers expect “continued rate hikes.”

The chairman is likely to “strike a tone that is both decisive and measured,” Krishna Guha, head of global policy and central bank strategy at Evercore ISI, said in a note to clients. Powell will note the “resilience of the real economy” while warning that inflation data has gotten higher and the road to taming it “will be a long and bumpy one.”

However, Guha said Powell is unlikely to hike rates by half a point or 50 basis points later this month, which some investors fear. Monday’s market prices suggested about a 31% chance of the larger move, according to data from CME Group.

“We believe the Fed will raise 50 basis points in March only if inflation expectations, wage and services inflation rise dangerously again, and/or incoming data is so strong that the median top interest rate ends up rising by 50,” Guha wrote . “The Fed cannot end a session further from its target than before the session started.”

However, the interpretation of the data will be difficult in the future.

Headline inflation may indeed show a sharp decline in March as year-on-year comparisons of energy prices will be skewed due to a jump in prices around this time last year. The Cleveland Fed tracker shows headline inflation falling to 5.4% in March from 6.2% in February. However, core inflation excluding food and energy is expected to rise to 5.7% from 5.5%.

Guha said Powell is likely to take the Fed’s end point for rate hikes — the “final rate” — to a range of 5.25% to 5.5%, or about a quarter point higher than policymakers’ December economic forecasts could.

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