The Federal Reserve’s top officials have signalled that high hurdles remain for any monetary policy tightening, as chair Jay Powell and his inner circle seek to steady the central bank’s message after almost a week of market gyrations.
In a series of interventions, senior Fed officials this week countered fears among some investors, and even lawmakers, that they were gearing up to raise interest rates more rapidly than expected in light of the fast-improving economic outlook.
Instead, they stressed their belief that the current US inflation surge is temporary, their commitment to doggedly pursue full employment, and their caution in withdrawing support for the recovery.
“We will not raise interest rates pre-emptively because we think employment is too high [or] because we fear the possible onset of inflation,” Powell said during a congressional hearing on Tuesday. “Instead, we will wait for actual evidence of actual inflation or other imbalances.”
The relatively dovish comments from the Fed’s leadership became necessary after a new batch of economic projections last week from US central bankers pointed to a two-notch interest rate increase in 2023, compared to zero expected just three months ago.
While the Fed has cheered a much brighter outlook for the recovery and said it was ready start debating a slowdown in the pace of its bond buying, it has not wanted to imply that interest rates rises are around the corner.
“Talking about rate changes now isn’t even on the table,” Mary Daly, president of the San Francisco Fed, told reporters on Tuesday. “The mantra right now is: steady in the boat.”
The reassuring tone was initially set by John Williams, the president of the New York Fed, on Monday, who said the data hadn’t “progressed” enough to warrant a change in policy. That marked a contrast to comments from James Bullard, the president of the St Louis Fed, at the end of the previous week, who signalled rates could rise as early as next year.
The combined remarks of Williams, Powell and Daly have offered some relief to investors, who have struggled in recent days against the backdrop of whipsawing financial markets.
US stocks fell sharply after the Fed meeting last week, the dollar rallied alongside government bonds, and market measures of inflation expectations declined as Wall Street weighed the prospects of the Fed becoming more aggressive in response to rising consumer prices.
On Tuesday, the technology heavy Nasdaq Composite climbed to new heights, the dollar steadied and the five-year break-even rate — which serves as a gauge for inflation expectations among investors — edged higher towards 2.5 per cent. It had fallen below 2.4 per cent on Friday.
The benchmark 10-year Treasury bond also pared back some of its previous gains, settling at 1.46 per cent after Powell spoke.
Brian Nick, chief investment strategist at Nuveen, attributed the reversal to the Fed’s success this week in affirming its patient approach.
“There’s a concerted effort on the part of Fed leadership to set the record straight on what its outlook is for rates, or at least to point out that it’s more data dependent than dot dependent,” he said, referring to the “dot plot” showing officials’ predictions of future interest rates.
“They’ve done some good in convincing markets the meeting wasn’t as hawkish as interpreted.”
Part of the challenge for the Fed in recent days was to reconcile the higher interest rate projections for 2023 with a new monetary policy framework introduced last year. The framework commits it to greater tolerance for inflation above its target of 2 per cent, compensating for periods of undershooting by seeking an average around the target. The framework also promises an “inclusive” definition of a tight labour market, encouraging job growth that benefits all segments of society.
“The Fed’s average inflation targeting framework has lost some credibility after last week,” said Eric Stein, chief investment officer of fixed income at the fund manager Eaton Vance.
“The Fed thinks about things from a risk management perspective and typically that risk is ‘inflation will be too low’ and so they are dovish. Last week was the first push back against [that] with some hawkish messaging.”
Officials have this week insisted that they remain deeply wedded to their new policy framework, rejecting any notion that they were wavering. “The market reaction to our framework and also the commitment to our framework is to be well solidified,” Daly said. “It’s something that will continue to play out in all of our policy decisions. I’m quite confident about that.”
But even if the Fed’s most senior officials appeared to steady the ship in the early part of this week, the events since their meeting last Wednesday highlight the potential pitfalls for the central bank as the economy enters a new phase.
“It is complicated messaging and a complicated framework at a complicated time,” said Kathy Bostjancic, chief US financial economist at Oxford Economics.