‘Smaller interest rate hikes could begin in December’- Fed Chair Powell

• On Wednesday, Federal Reserve Chairman Jerome Powell said we could see smaller interest rates in December
• He cautioned that monetary policy would stay restrictive until inflation figures consistently show positive signs.

Federal Reserve Chairman Jerome Powell confirmed that there might be smaller interest rate increases ahead although he sees progress in the fight against inflation as vastly inadequate.

Powel, echoing recent statements from other Central Bank officials and comments at the November Fed meeting, said he sees the Central Bank in a prime position to reduce the size of rate hikes as soon as next month.

He, however, warned that monetary policy might stay restrictive until the inflation numbers show real signs of progress. Powell said in his remarks at the Brookings Institution, “We have a long way to go in restoring price stability despite some promising developments.”

The Chairman stated that critical policy decisions such as raising interest rates and reducing the Fed’s bond holdings take time to work their way to the economy. He said, “As we approach the level of restraint that will be enough to drive inflation down, it is important to moderate the pace of our rate increases”. He added, “the time to moderate the pace of rate increases may be this December meeting.”

“We will stay the course until the job is done”- Fed Chairman

Powell also answered questions on the timing of the moderation and how long it may take to raise rates to tackle inflation. He stated, “The timing of the rate moderation is not as important as the questions of how much further we will need to raise rates to control inflation and the length of time we need to hold the monetary policy at a restrictive level” 

He added, “We may need to hold the monetary policy at a restrictive level for some to achieve price stability.” “We will stay the course until the job is done”, he submitted. 

“Inflation remains much too high by any standard’- Powell

With Powell’s remarks, there are indications that inflation may be waning. November’s consumer price index indicated rising inflation but by less than what market analysts had predicted. 

However, the Fed Chairman warned that short-term data might be deceptive and only consistent positive signals will impress him. For instance, he said the Central Bank’s preferred core personal consumption expenditures price index in October, which will be released on Thursday, is expected to reflect a 5% annual pace in inflation. While it will be 0.1% lower than in October, it is still far from the Fed’s 2% long-run target. In his words, “It will take substantially more evidence to convince us inflation is actually declining as inflation remains much too high by any standard.”

Powell also expects the terminal rate( the ultimate peak for rates) to be “somewhat higher than thought.” The Federal Open Market Committee (FOMC) expected the terminal rate to hit 4.6% in September, and markets now see it in the 5%-5.25% range. 

“Tight labor market needs to keep up with 2% inflation”- Powell

Powell also made remarks about the labor market. In his words, the labor market has shown “only tentative signs of rebalancing” after the ratio of job openings to available workers fell from 2 to 1 margin to 1.7 to 1. While the gap closure is encouraging, it remains well above historical norms. Also, he stated that the tight labor market has to keep up with inflation.

“To be clear, strong wage growth is a good thing. But for wage growth to be sustainable, it needs to be consistent with 2% inflation,” he said.

Powell went into detail on the causes that keep labor force participation low, which is critical in correcting the mismatch between vacant jobs and available employees. He described “excess retirements” during the Covid pandemic as a significant cause of the situation.

Wall Street reacts to Powell’s remarks

Powell’s remarks were well received all over Wall Street as the Dow Jones Industrial Average closed up 737 points to end a three-session losing streak on Wednesday. Tech stocks also performed strongly, with the Nasdaq Composite rising by 4.41%. Many investors had been apprehensive of the Fed’s move, expecting hawkish body language. 

According to CME data, market analysts had put a 65% probability for the Fed to step down its interest rate increases from 0.75 to 0.5 points in December. The probability has shot up to 77% since Powell’s speech. 

In the aggressive Fed move since the early 1980s, The Federal Reserve raised interest rates by 0.75 points successively four times in 2022.