Powell changed everything this week on the market’s view of interest rates

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

Kevin Lamarque | Reuters

Federal Reserve Chairman Jerome Powell’s prepared speech this week to Congress took just a few minutes, but it changed everything.

In those remarks, the central bank chief outlined a new paradigm for how the Fed views its policy path, one that appears to see interest rates even higher for a longer period of time than previously thought. expectation

The result has caused the market, which had long been looking for the Fed to intervene in its fight against inflation, to rebalance its own views to coincide to policymakers who have been warning of a higher approach for interest rates.

“It’s clear that we’ve had a chorus of Fed speakers for two weeks that was getting us to that place,” said Art Hogan, chief market strategist at B. Riley Wealth Management. “It took Jay Powell, over a very short prepared statement and Q&A, reinforced those expectations to a higher level.”

As part of his semiannual testimony on monetary policy, Powell spoke Tuesday before the Senate Banking Committee and the day after to the House Financial Services Committee.

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Going into the odds, markets had been looking for the Fed to raise its benchmark interest rate by 0.25 percentage point at its meeting later this month, and maybe two more moves before they stop, with the end point around 5.25%.

That changed after Powell’s appearance, when he warned that if inflation data remains strong, he expects rates to go “higher than previously expected” and possibly at a faster pace than a quarter of a point at the same time.

Markets are now strongly anticipating a half point hike in March and the top rate, or cap rate, hitting close to 5.75% before the Fed is done.

When the facts change

So what changed?

Basically, it was January inflation data and signs that the labor market is still very strong despite the Fed’s efforts to slow it down. That prompted Powell, who only weeks earlier had talked about “disinflationary” forces at play, to switch gears and start talking tough again about monetary policy.

“It’s changing to data coming in, which the whole board should be doing,” said Hogan. “If the facts change again through the February and March data, it will likely become flexible in that direction and not push it too far to the point where they have to do something break “

In fact, Powell said he will be keeping a close eye on an important set of data coming up — Friday’s nonfarm payrolls report, followed by next week’s look at the consumer and producer price indexes.

Goldman Sachs economists are sticking to their forecast for a quarter-point hike at the March 21-22 Federal Open Market Committee meeting, but admit it’s a “close call” between that and half a point .

If the Fed were to go into a more aggressive stance, Goldman warned in a client note that it could have a market impact, with stocks selling off “sharper” and weighing down on commodities, and weighing up on the dollar.

Worrying about the consequences

Powell faced some questioning this week about the Fed’s inflation-fighting strategies.

Some more progressive lawmakers like Sen. Elizabeth Warren (D-Mass.) and Rep. Ayanna Pressley (D-Mass.) charged that the rate hike would lead to 2 million layoffs and hurt working-class families disproportionately. Powell countered that inflation is also hitting those at the bottom of the income spectrum.

“This is what he’s supposed to do,” Joseph Brusuelas, chief economist at consulting firm RSM, said of Powell’s policy stances. “Jay Powell is a punching bag in Washington at this point. . He is going to take the blame for establishing price stability. If he does that well, in the years to come he will be honored. People will talk a lot about it.”

Brusuelas is among those who believe the Fed should step up its inflation battle with a half-point rate hike.

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

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“The economy is just too stable at this point,” Brusuelas said. “They need to generate enough labor to cool the economy.”

Slack was not featured in this week’s Labor Department report on job openings in January, which outnumbered available workers by a 1.9 to 1 margin.

Such data could push the Fed to tighten more, according to economists at Nomura. The company said future actions could include changes to the Fed’s program to cut down its bond portfolio, with one option being the removal of the $95 monthly reduction cap. billion currently.

At the moment, markets continue to push prices at higher levels.

Although Powell made a point on Wednesday to emphasize that no decision has yet been made on the March rate move, markets ignored him. Traders in the futures market were pricing in a close of 5.625% later this year, well above what it was before Powell spoke.

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